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The inflation figures for the UK released last week were as follows: RPIX 3.5%, RPI 3.2%, CPI 2.3%, and core inflation 2%. These figures were all considerably worse than expected, and while the RPI measures may be regarded now as a somewhat historic measure (although not for those who hold investments that benefit from guaranteed RPI-linked uplifts), the CPI is the targeted measure and the MPC had been trying to divert attention towards the core measure. Or, rather, it was while the core measure was reflecting a level considerably lower than the CPI measure.
There are some mitigating factors in the rise of the inflation numbers. This time last year the oil price was falling and having a beneficial effect on inflation. These price reductions have no repeat this year, with last year’s deflationary movement now being reversed out of the index. In fact, oil price is about 10% higher than last year in USD terms which, together with the depreciation of the pound, has caused a 0.8% movement in the figures by itself.
However, it was the rise in the core figure that has taken most commentators, including the Bank of England, by surprise. It is not so much that the items contained within the core measure (household goods, services etc) were not expected to be impacted by the depreciation of the pound, just that it has happened much faster than the forecasters had expected. This, in turn, has inclined some to raise their forecasts on the likely peak which the CPI measure will reach. Previously, the median view was that 2.8% should just about see the summit of the upwards trend, with a few pessimists looking to hit the 3% mark. The latter has probably now become the median for a top out level, with several economists looking for it to be exceeded.
One would have thought that these inflation figures might have been greeted with some dismay by the market. However, rates hardly budged as the Bank of England’s strong message that it is inclined to ‘look through’ the figures has been well absorbed by the market. This despite one MPC member voting for a rise last month and a couple of others noting that the current lax monetary policy was starting to wear thin with them at this month’s meeting.
Perhaps what is more surprising, is that the UK market is managing to maintain a very flat yield curve. The gap between three-month USD Libor/Euribor and the five-year swap rate is 0.82% and 0.50% respectively. In the UK it is a mere 0.44%. Meanwhile, the actual trading level for USD five-year swaps is some 1.20% higher than their UK equivalent. Given that UK rates have always been more influenced by USD levels rather than EUR, it is questionable just how wide a divergence they may be able to achieve in comparison with USD rates – both short and medium term. Currently, USD three-month rates are trading at 0.80% higher levels with the expectation that the Fed will raise short rates at least twice before the year is out. Maintaining UK short-term rates at unchanged levels may prove very difficult to achieve without another major depreciation in the pound, which would then feed through to yet higher inflation levels.
The event that all have been waiting for arrives on Wednesday, as the triggering of Article 50 formalises the UK’s departure from the EU. It seems fairly certain that the first issue that will need to be addressed is that of those who live and work as migrants in the EU and the UK. This is much more important to the UK than the EU countries, as our health service and industries like construction, engineering, fintech and financial services employ many more EU passport holders than you will find UK citizens working in the EU. Had the government accepted the House of Lords amendment to guarantee the rights of EU nationals living and working in the UK, we would have assuaged their fears of upheaval and removed the uncertainty that a period of negotiation will bring. Indeed, if the Government had acted unilaterally, it would have left the EU with little alternative but to follow suit. Let us hope that this resource, which is so vital to this country’s economy, is not risked through pro-Brexit negotiating shenanigans.
Another, much more difficult, immediate negotiation will be over the divorce bill. Forget about the line that is peddled that the UK can walk away without any payment. The EU will insist that the UK must meet its financial obligations and is unlikely to move on to any other matters, and certainly not trade agreements, until this is settled. As it involves agreement with 27 countries and will be disrupted by French and German elections, not much progress can be expected until the autumn.
The problem is that it is not immediately obvious how one will calculate what our share of the EU obligations actually is, due to the EU’s inability to produce verifiable accounts. The situation is further muddled by the UK having to remain within various EU agencies because setting up separate UK agencies to perform the same functions is just not possible within a two-year period. According to today’s Financial Times, it is estimated that the UK will have to set up as many as 34 regulatory agencies to replace those functions currently undertaken on an EU-wide basis. It sounds like the largest civil service recruiting requirement ever seen and should be good for the unemployment numbers.
In comparison with triggering Article 50, all other news is insignificant. However, it will include the latest money supply, consumer credit and mortgage approvals on Wednesday, GfK consumer confidence index on Thursday, and the latest current account data and final confirmation of the fourth-quarter GDP figure.
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