Tuesday, September 15, 2009

UK: New data, same problem

I remain convinced that most developed markets' economies exhibit much less inflation pressures than is generally believed. Core inflation rates will fall further and nominal growth rates will remain muted for a prolonged period of time. However, I am seriously worried about the developments in the UK. I previously argued that I see the most pronounced risk of an inflationary outcome for the UK (see for example: Revisiting the UK: Not much good news dated August 18) and highlighted the disappointing development of UK inflation relative to the US and the Eurozone. Today, the August CPI data were published. Unfortunately, they did nothing to change my downbeat assessment as inflation once again overshot consensus and core inflation failed to moderate.
True, yoy inflation fell further, to 1.6% from 1.8% in July. However, this was once again above consensus expectations (which were looking for a 1.4% reading). Furthermore, compared to the US and the Eurozone, the UK's inflation moderation during the current year remains much more muted (last US and Eurozone numbers are for July):
Source: Bloomberg, Research Ahead

Moreover, as mentioned above, inflation has continued to overshoot expectations. As the chart below shows, this is unfortunately the rule rather than the exception. The chart adds the difference between actual inflation (mom value) minus the forecasted value (Bloomberg consensus). While during 2007, US inflation tended to overshoot vs. expectations, since mid 2008 this has been the reverse. In the Eurozone (I have used German inflation as it is been released relatively early), inflation tended to be more or less in line with expectations. In the UK, however, since early 2008, the consensus has consistently underestimated inflation (be it on the way up during early 2008 as well as on the way down over the past months). This was evident again today where actual mom CPI came in at 0.4% vs. expectations of 0.3%:
Source: Bloomberg, Research Ahead

Finally, core CPI in the US and the Eurozone has been falling (albeit slowly) on a trend basis since late 2008. However, UK core CPI has been increasing over the course of this year! This trend has been confirmed today with yoy core CPI remaining unchanged at 1.8% vs. expectations for a fall to 1.6%.
Source: Bloomberg, Research Ahead

Therefore, I can only repeat my conclusion reached in mid-August:
"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."

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