August 5 2022
This week was always going to be about the Bank of England and it indeed proved to be the case. The market fully expected that the Monetary Policy Committee (MPC) would raise rates by 0.5% to 1.75% and they delivered accordingly. This was the largest increase seen in 27 years. This move was supported by eight of the nine committee members, with the ninth preferring a 0.25% hike. They also kept up a pledge to act forcefully again if need, which potentially means that we could see further hikes of this magnitude in the future.
The latter is looking more likely after the latest inflation forecast produced by the Bank, where they now forecast that inflation could reach 13% later this year and remain at very elevated levels through 2023, before falling to the 2% target two years ahead.
The interest rate hike comes despite their warning regarding the UK economy. In their latest outlook they recognise that inflationary pressures, along with tighter monetary conditions, have led to a further deterioration in global economic activity, with the UK and Europe, one of our major trading partners, particularly affected. They now forecast that the UK economy will enter a recession later this year, contracting from the fourth quarter and each quarter thereafter to the fourth quarter of 2023. The peak to trough fall is expected to be in the region of 2.25%.
After the US Federal Reserve was perceived to have pivoted to a more dovish outlook last week at their interest rate setting meeting, committee members have been out in force this week singing from the same hymn sheet, reinforcing that their expectation is that they are still nowhere near a turning point on rate hikes. No fewer than six members were heard reiterating the message. One member still believes that the rate should rise to 3.75%-4% by year end and that he would need to see convincing evidence of easing inflation to change his view. Another member meanwhile believes the possibility of the Federal Reserve pivoting to cutting interest rates next year is extremely unlikely. “Some financial markets are indicating they expect us to cut interest rates next year,” Kashkari said, adding “I don’t want to say it’s impossible, but it seems like that’s a very unlikely scenario right now given what I know about the underlying inflation dynamics. The more likely scenario is we would continue raising interest rates and then we would sit there until we have a lot of confidence that inflation is well on its way back down to 2%.” Fighting inflation therefore, it would appear, still remains firmly in the headlights.
Whilst there is an official inflation figure produced across every nation, we have argued, along with others, that everyone’s own inflation is different to someone else. This is a point raised by BrewDog this week, who believes that the official figure in the UK is nothing like the full picture. The CEO and co-founder, James Watt, reported that it is costing them 25% more to make a case of Punk IPA today than it did in 2021. Their input costs continue to rise rapidly, having already seen huge increases in the price of electricity, gas, transport logistics, wages, malted barley, hops, along with packaging materials such as aluminium and cardboard.
Whilst they, along with other manufacturers and retailers, can potentially live with making less margin in the short term, this is unsustainable. This, they believe, gives product manufacturers with two difficult options at the moment, either pass on the increase in costs which they themselves are seeing or, producer a smaller or inferior product for the same price.
The issues pointed out by BrewDog highlights a number of discussion points:
1. Corporate profits margins are clearly under pressure given the high levels of inflation being seen, but to what extent?
2. Are there a lot more price increases still yet to come through into the system, keeping inflation higher for longer?
3. How appropriate or realistic is the inflation basket on which official inflation is calculated?
4. If goods are to get even more expensive, what is the impact on consumer spending power and economic growth?
These are no doubt questions which monetary policy makers, business owners and leaders, consumers and investors are no doubt looking to try and answer. What is your level of inflation and can you stay ahead of it?
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