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What have we been up to


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Inflation, rates and Trump

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It has taken a long, long time but inflation is taking off. In the US, annualised CPI reached 2.1% in December. In the UK, the equivalent figure came in last week at 1.6% - stronger than the 1.4% expected and making the MPC’s post referendum interest rate cut and £60 billion addition to QE look even more of a mistake. Even in the eurozone, CPI increased steadily from 0.1% to 0.6% between June and November last year, before accelerating to 1.1% in December.
Inflation, of course, suits the indebted and no one is more indebted than government. Therefore, despite their notional independence, we would not be surprised to see central banks remaining ‘behind the curve’, deliberately keeping interest rates lower than the level required to properly tame rising prices. This would represent a risky policy of allowing inflation to run above target in order to reduce the real value of the respective national debt piles.
However, there are limits to such a plan. In the past, such attempts have usually been very successful at stoking inflation – indeed too successful, the difficulty being that once inflation takes off it requires ever more brutal interest rate hikes to bring it back under control. And unless the plan is to completely debauch fiat currencies (possible but unlikely), above-target inflation must eventually be controlled with higher rates.
Alternatively, the central banks may act responsibly and deliver just the right amount of monetary tightening to reign in the nascent inflationary forces without damaging the respective underlying economies. But either way – and this is the point – inflation is on the march again and rates are set to rise. The sooner the central banks act, the less aggressive the required monetary medicine will be.
This is why the ECB’s line of ‘looking through’ the current uplift in German inflation is proving so controversial. After last week’s ECB council meeting, Mario Draghi was relaxed about the prospect of apparently remaining behind the curve, saying: “as the recovery will firm up, rates will go up as well.” While that will be true at some stage, for now, with eurozone core CPI at a mere 0.9%, a tightening of policy looks some way off. This will make the Germans hot under the collar as they consider their own  inflation rate of 1.7% in December, sharply up from November’s 0.8%.
In the UK, the future course of monetary policy is similarly nuanced. Here the two opposing drivers are the inflation which has started to creep up after sterling’s sharp post-referendum depreciation and the prospect of a slowdown as possibly portended by last Friday’s surprisingly weak retail sales figures which fell 2% month on month between November and December. One swallow does not a summer make, nor one poor statistic a recession, but the normally metronomically reliable British consumer seems to have had a pause for thought in the run up to Christmas. Perhaps this is only to be expected given the almost ‘fin de siècle’ – and very surprising – enthusiasm with which the British were spending throughout the summer and autumn.
Thus, both the ECB and the MPC will be giving consideration to raising rates over the next few months but will be cautious lest, in the ECB’s case, higher rates damage weaker member states, and in the MPC’s case, they reduce consumer confidence. Both, it should be stressed, will tolerate above target inflation, at least in the short term.

Turning Stateside, President Trump’s inauguration speech last Friday was extraordinary. Sounding at times as if he had gathered his material from a Bruce Springsteen album (“Rusted-out factories scattered like tombstones across the nation”), the President promised infrastructure spending to “get people off welfare”; to buy American and hire American; and to “eradicate Islamic terrorism from the face of the earth.” “Most importantly, we will be protected by God,” he added for good measure. Thank heavens for that, otherwise the President really would have a job on his hands.
There were a great many promises but the main economic theme was that the President will bring jobs back to America with his infrastructure splurge and all will be well. It is all rather too reminiscent of teenage years when many believe that politics is a simple thing and that, if only they had sufficient power, they could solve all their countries’ and the world’s problems. Would it were true. The danger is that Trump, like Obama, will disappoint and achieve less than he would like and, crucially, less than the markets currently expect.
The first hurdle could be Trump’s own Congressmen and Senators, many of whom have a visceral and ideological dislike of anything that smacks of ‘big government’ – huge infrastructure projects, for example! Time will tell but if Trump’s plans run into trouble with his own party, a reined-back infrastructure programme could mean US rates not rising as much as the market currently predicts (10 year Treasury yields have risen over 65 basis points in just over two months), with a consequent unwinding of some of the recent dollar strength.
Back in the UK, this week sees Public Sector Net Borrowing for December (tomorrow, expected 6.8 billion, down from November’s 12.2 billion); BBA home loans (Thursday, expected 41,000 up from 40,659); and Q4 2016 GDP (also Thursday, expected up 0.5% q/q and up 2.1% compared to Q4 2015). Tomorrow also sees eurozone PMI data which is expected to continue the relatively upbeat trend (manufacturing and services expected 54.8 and 53.8 respectively). PMI data will also be released in the US: manufacturing, tomorrow, expected 45 and services, Thursday, expected 54.6, while Friday will see US Q4 GDP (expected up 2.2% y/y).
In the meantime, markets will continue to digest Theresa May’s ‘clean Brexit’ speech last Tuesday which was reasonably well received on both sides of the Channel. The Supreme Court will opine tomorrow on whether parliament will need to vote to trigger Article 50 (if the answer is yes, expect a sterling rally); and market participants will be bracing themselves for President Trump’s promised significant policy announcement in his first week of office, at the end of which he will meet Theresa May in Washington. It promises to be a very interesting week.
James Stretton

All views expressed here are the Author’s own and are based on information available at the time of writing.



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