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Inflation and May’s June bombshell

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Many prefer Easter to Christmas on the grounds that Easter has all the good things associated with Christmas but with less of the commercialism. While still the case, the arrival of cheap air fares has shifted the balance somewhat. Nowadays, while Easter still cannot compete with the shopping-fest of Christmas, the 'moveable feast' nonetheless generates a spike in consumption on account of expenditure on holidays.

Few travellers will have consulted the heavens this year to work out which day reflected the first Sunday after the first full moon following the vernal equinox. Nonetheless, the complicated historical calculation of Easter Day means that it moves around from anywhere between 22 March and 25 April.

Last year, Easter and its dramatic impact on the price of air fares, came in March. This year it was April and therefore its effects were absent from the year-on-year CPI data for the year to March. This probably depressed March CPI by 0.2% or more, hence, at 2.3%, the official inflation rate was unchanged from February.

This year, the 'Easter flight effect' will manifest itself in April’s inflation data which will be released in May. Combined with the recent rise in the oil price, which has led the price of petrol to increase by 11% in the year to 10 April according to the RAC Foundation, this could easily see next month’s CPI increase rising above 2.5% - taking real short-term interest rates to minus 2.25%. This is the trouble with the MPC’s policy of ‘looking through’ supposedly short-term blips in inflation. The more one ‘looks through’, the more negative real interest rates become and the greater the stimulative effect on the economy. Conveniently, the real value of the national debt is also reduced.

Twice in the last decade – in 2008 and 2011 – the MPC allowed CPI to reach 5.2% without raising rates but there was surely more justification for the policy in those days, given the severe underlying deflationary forces at the time. This time around, despite the MPC’s obvious temptation to make up for the protracted period of below-target inflation that began in 2014 and only ended in February this year, the committee appears to be playing with a much hotter fire.

The problem has been compounded from a political perspective by the freeze on working-age benefits and the cap on public sector pay of 1%, introduced by the ever-popular George Osborne in his post-election budget of July 2015 and set to last until 2019. Already the nurses are up in arms, with the Royal College of Nursing claiming, no doubt correctly, that real nursing pay has declined by 14% since 2010. Higher up the scale of medical remuneration, GPs are retiring in record numbers as they see the cut to £1m in the lifetime allowance for pensions effectively removing 25% of any pension above £50,000. They should consider themselves lucky. In the private sector, at current annuity rates, the 25% tax comes in at an annual pension income of about £25,000.

Theresa May’s government has been accused of late of being too overwhelmed by Brexit to concentrate on anything else. With a wafer-thin majority, and real wages now stagnating in the private sector and declining at an accelerating rate in the public sector, the PM would have found it increasingly difficult to maintain her laser-like focus on Brexit – or indeed negotiate effectively. This morning’s announcement of a June the 8th General Election has the potential to change all that if as expected, the Conservatives return an increased majority.

The Prime Minister said that she had made the decision to go to the country ‘recently and reluctantly’, not surprisingly, as she has performed a very sharp U-turn. However, it is unlikely to be plain sailing. Firstly, she must secure a two-thirds majority tomorrow to overturn the Fixed Term Parliament Act. Secondly, since she must consider what sort of Conservative vision of Brexit she will present to the electorate in the run-up to the election. The answer is likely to be ‘hard’. Anything else will weaken her negotiating position in Europe as well as splitting the Tory party. However, if she is short on detail, as anything but the most diamond-hard proclamation will demand, she will effectively be asking the British people to take her on trust to deliver the best deal for Britain (as was, of course, the case until this morning). It may prove difficult to get away with this without allowing the electorate to vote, yet again – this time on the outcome of negotiations in 2019.

Were there an effective opposition, this would look like an almighty gamble. However, Her Majesty’s Opposition is not an issue that much troubles the PM at the moment. The Labour Party will surely vote with the government tomorrow, or risk being accused of ‘running away’. Then the question will be how many Tory Remainers regard the European issue as more important than party and therefore turn out to vote for the Lib Dems, who will fight the election on an anti-Brexit ticket. Certainly, anti-Brexit feeling is still riding sufficiently high in many quarters for the Lib Dems to return a multiple of their current nine MPs. As for trying to calculate the number of traditional Labour Leavers who will be persuaded to vote Tory to secure Brexit, the number must be irreducibly small. This is the risk inherent in the snap election plan – many of the 52% Leave vote would, under no circumstances, vote Tory.

The markets are, for the time being, taking all this in their stride. Sterling had a good week last week, and after a wobble this morning ahead of the election announcement now trades at 1.2750 and 1.1925 against the dollar and euro respectively. However, sterling is in something of a win/win situation after this morning’s news. If May wins, she benefits from a stronger mandate; if she loses, the chances of Brexit reduce.

While Theresa May’s premiership suddenly looks like it is going to get much more interesting, Donald Trump’s presidency just gets more confused – or confusing if one is charitable. On the campaign trail he promised to get the American economy motoring again with massive fiscal stimulus and suggested that Janet Yellen should be ‘ashamed’ for having kept rates so low for so long. Not surprisingly, after his victory, market participants piled into the dollar on the premise of tighter monetary and looser fiscal policies – the dream ticket for a currency.

Now, with the Obamacare repeal bill rejected, all Trump’s fiscal plans are coming under greater scrutiny and half the reason to hold the greenback is evaporating. As if that were not bad enough, last Wednesday, Trump himself questioned the wisdom of a strong dollar: “It’s very, very hard to compete when you have a strong dollar and other countries are devaluing their currency.” The President also did not rule out offering Janet Yellen a second term, though he did state his preference for low-interest rates, in another change of tack from the campaign trail. He also refused to describe the Chinese as currency manipulators.  One is reminded of the comment of one of the crowd in Monty Python’s Life of Brian that he is ‘making it up as he goes along’.

The dollar, of course, weakened on the comments but perhaps not as much as might be expected, given they came from the leader of the free world. Whisper it in the White House but the President’s ability to move financial markets through rhetoric is waning fast. Traders and investors are fed up with the volte-faces, curve balls and googlies. If Donald Trump wishes to maintain any influence over the markets, he could do worse than try a period of vocal abstinence. He has missed Lent but there are plenty more opportunities available. 

There is not much data this week. Tomorrow sees Eurozone inflation which is expected to have remained unchanged at 1.5% y/y in March, while Eurozone PMIs on Friday are expected to forecast steady expansion, with April’s composite number unchanged at 56.4. Friday also sees UK retail sales – expected +3.3% y/y. Anything much below this will indicate that consumers are starting to struggle as real earnings growth stagnates.

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