Wednesday, January 20, 2010

UK: Nothing New on the Northern Front

Just a quick update amid the latest UK inflation numbers. Last year I wrote several times about the challenges facing the UK (see for example UK: New Data, Same Problem dated Sep 15).
I concluded that "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."

UK inflation has been showing a worrisome trend for quite some time, especially compared to the developments in the Eurozone and the US. The chart below highlights the core inflation developments. One should not forget that UK core inflation was artificially depressed in Dec08/the start of last year due to the temporary cut in VAT. But ever since it has been trending higher throughout compared to a slow grind lower in the US and a more pronounced downward movement in the Eurozone.
Core CPI: UK developments become even more worrisome
Source: Bloomberg

Moreover, 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 headline 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. This was evident again yesterday where actual mom CPI came in at 0.6% vs. expectations of 0.3%:
Source: Bloomberg, Research Ahead

In turn, inflation is clearly misbehaving and much more so than was expected. This adds to the challenges for the UK economy overall (much too high fiscal deficit, significant de facto monetisation of the defict via QE, substantial current account deficit, very substantial exposure to and dependency on the financial sector, still overvalued housing market). But also for the overindebted and undersaving consumer this inflationary development does not help ease the debt burden. What matters for the consumer is not the level of inflation but what happens to wages. Inflation per se does not render serving the debt any easier, only higher income does! And wage income has not grown substantially. In fact, according to the latest data available average earnings were up by only 1.8% yoy in November. This does not help much to ease the debt burden. More importantly, it constitutes a real wage loss which clouds the outlook for consumption growth. The chart below compares headline CPI with the development of yoy average earnings (including and excluding bonuses). As can be seen, average earnings grew by much more than CPI over the past decade, resulting in a real wage gain. However, in 2008, the oil price shock has briefly resulted in a real wage loss. Thereafter, average earnings excl. bonuses were trending lower in line with CPI. Now, however, the spike in inflation results again in a substantial loss of purchasing power.
Average earnings cannot keep up with the spike in inflation
Source: Bloomberg

I remain worried by the longer term outlook for the UK economy and continue to stick to my negative assesment with respect to GBP-related assets. Look for futher underperformance of Gilts vs. Bunds and also US Treasuries.

No comments:

Post a Comment