I already previously highlighted my worries with respect to the medium-term outlook for the UK (The UK: down and out dated July 7). While in the meantime the recovery has continued, my doubts about the UK outlook have not become less pronounced, rather to the contrary. I remain seriously worried about the more longer-term outlook and consider the risks for an inflationary outcome as being the most pronounced by far of any of the larger non-EM economies (I continue to expect US and EUR nominal growth to be very low for a multi-year period amid low real growth and low inflation).
Just to repeat: I think the structural problems the UK economy is facing are even more substantial than elsewhere. For one, the structural imbalances (overvalued housing market, over-indebted under-saving consumer, high current account deficit to name a few) are at least as pronounced as in the US. However, the banking sector liabilities are significantly larger and the share of the financial sector is larger than in the US.
For me, the key reason for the positive UK data surprises of the past months are down to the larger macro-economic stimulus than for example in Europe. First, the BoE was faster in cutting rates than the ECB and also engaged in a more aggressive asset purchasing program sooner. Additionally, the fiscal stimulus in the UK is significant. Finally, the drop in GBP on a trade-weighted-basis has provided an additional boost.
However, there is a real problem brewing and today's CPI release highlighted this again.
Yes, inflation in the UK has come down as well during the past quarters, however, this fall was much less pronounced than in the US and the Eurozone (yoy numbers):
Conclusion: I remain seriously worried about an inflationary outcome in the UK (in contrast to the US and the Eurozone) and suggest to underweight the UK from an asset allocation perspective. UK Gilts risk underperforming significantly vs. the US and Eurozone counterparts over the medium term and yields are likely to rise over the next quarters.