August 26 2022
The latest inflation forecast for the UK from Citi took the market by surprise this week. Updated for a further rally in gas and electricity prices, they believe that a further upside shift in inflation is highly probable and that CPI could peak at over 18% in January. This is some way above the 13.3% predicted by the Bank of England in their latest report.
Since the beginning of August we have now seen a marked upward shift in interest rate expectations for the UK, as predicted by overnight index swaps data from the Bank of England. On the 01 August the implied interest rate 12 months forward was 2.75%. This, as at the 24 August, has now risen to 4.37%. Looking at the forecast for 5 months, taking us just past year end, we see that the implied interest rate has risen from 2.58% to 3.55%, using the same reference points as above. As a consequence the ten year gilt yield has risen quite sharply. Since the 19 August it has risen from 2.415% to 2.628% at the time of writing. Since the 01 August meanwhile the yield has risen from 1.809%.
Energy price rises continue to be an issue and a significant contributor to higher inflation figures. Whilst this is due to a pick-up in demand, whether that be for use or storage ahead of the winter months, it is undoubtedly due to the issues regarding Russia, whether that be countries looking to use alternative sources or the slow supply from Russia itself.
These pressure are not just here in the UK, but notably in Europe also. As per figures from the European Union Agency for the Cooperation of Energy Regulators, the degree of dependence varies across the continent. North Macedonia for example take 100% of their gas supply from Russia. Finland meanwhile take 94% and Bulgaria 77%. Even countries such as Germany rely on Russia for 49% and Italy 46% of their usage, or at least did.
The impact of higher energy prices is clearly inflationary. However, is it the right inflation? The additional cost to heat and light our homes, drive our cars, etc, will undoubtedly, if not already, supress or rule out the consumers ability to spend on other goods and services. In a sense, higher energy costs become almost like a tax. This is something reflected on by the CEO of Octopus Energy this week, where he was quoted as saying “Let’s put this in perspective: the UK’s energy bills are going to go from £15bn in a normal year to £75bn this year – that’s the equivalent to 9p more on the basic rate of income tax.” Or to quote Milton Friedman, “inflation is one form of taxation that can be imposed without legislation.”
UK manufacturing PMI’s are already registering an index reading of 46, with a figure under 50 suggesting contraction in that sector. The service sector remains in expansion, with a reading of 52.5 for August, but all eyes will be looking for any significant deterioration.
The Jackson Hole Symposium is currently underway as we write, entitled “Reassessing Constraints on the Economy and Policy.” All eyes will be on US Fed chair Powell’s speech, where they will be looking for pointers as to whether the central bank is to continue as aggressively with its recently monetary policy tightening, or whether a more dovish pivot lies ahead.
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