A record-high jump. That is how several financial commentators we follow described the “Consumer Price Inflation” report for August, which showed the the Consumer Price Index (CPI)—a broad measure of goods and services prices—rising 3.0% y/y.[i] That figure is up from 2.1% y/y in July, and as the Office for National Statistics noted, the acceleration in the inflation rate is the largest since official records begin.[ii] Many analysts and industry groups quoted in financial commentary we read warned of further price pain in store for UK consumers. It likely also creates extra work for Bank of England Governor Andrew Bailey, who is required to write a letter to the Chancellor whenever inflation veers at least one percentage point from the BoE’s 2% year-over-year target. For investors wondering how inflation might affect the outlook for shares, however, we don’t think it is necessary to parse an official communiqué—in our view, US inflation trends offer a helpful preview, as they embarked on this course several months before the UK due to the US’s earlier reopening from lockdowns.
Whilst Freedom Day in the UK of course arrived in mid-July (and even then was disrupted by the so-called Pingdemic), most US cities and states had reopened by this past spring. When they did, we think it freed consumers to unleash all the demand pent up from a year of not travelling, shopping or dining out much. At the same time, inventories of several consumer goods were running lean due to lower production during the COVID lockdowns, and many services were understaffed and overwhelmed by the initial influx.[iii] The collision of high demand and weak supply drove prices higher. America’s CPI inflation rate jumped from 1.7% y/y in February to 2.6% in March, 4.2% in April, 5.0% in May and 5.4% in June and July.[iv]
Yet rising prices in those months weren’t solely responsible for the sharp acceleration in inflation. A mathematical phenomenon called the base effect was also at work. This refers to abnormalities in the denominator (aka base) of the year-over-year inflation rate calculation—or, more simply, fluctuations in prices a year ago. In this case, it was the temporary deflation that accompanied America’s lockdowns in March, April and May 2020. This created a low comparison for prices in spring 2021—a higher numerator (prices in 2021) divided by a temporarily smaller denominator (prices in 2020) yields a faster inflation rate.
According to the ONS’s press release, the UK is now experiencing the same phenomenon. The most striking example, in our view, is food prices, which—along with hotels—made their largest-ever contribution to the inflation rate. As the ONS explains: “This upward contribution was largely driven by widespread discounting of restaurant and café prices in the previous year. The government's Eat Out to Help Out (EOHO) scheme ran in August 2020 and offered diners a 50% discount (up to a maximum of £10 per diner) on food and non-alcoholic drinks to eat or drink in every Monday, Tuesday and Wednesday at participating establishments. At the same time, a reduction in Value Added Tax (VAT) from 20% to 5% for the hospitality sector also contributed to a fall in prices.”[v] In other words, prices today are being compared to a year-old government discount programme. Once that programme leaves the calculation over the next few months, we think it is logical to view a moderation of the food inflation rate as likely.
In our ongoing analysis of American inflation data, we have attempted to tune out potentially false signals from the base effect by focusing on the month-over-month changes in CPI. To that end, we thought it noteworthy that whilst the year-over-year inflation rate slipped only a bit in August, from 5.4% to 5.3%, the month-over-month rate fell from 0.9% in June to 0.5% in July and 0.3% in August.[vi] As it happens, 0.3% is also America’s average month-over-month CPI inflation rate since data begin in 1947.[vii]
We have also found it helpful to go a step deeper and look at the month-over-month changes in individual categories. In doing so, we found that most of 2021’s price pressures were coming from the categories affected directly by reopening: travel and leisure, automobiles, transportation services, food and energy—incidentally, many of the same categories the ONS highlighted as major contributors to UK inflation in August. Some of these stemmed primarily from the unleashing of pent-up demand as people were finally able to travel and dine out again (e.g., airfares, hotels and fuel). Others received an assist from shortages, as resurgent demand coincided with supply chain kinks (e.g., food, automobiles and rental car prices). Used automobile prices, which jumped 31.4% between February and July (and contributed to UK August inflation), were at the nexus of all these factors.[viii] According to several industry reports we reviewed, reopening spurred demand for cars, but the global semiconductor shortage drove a shortage of new vehicles. That apparently forced shoppers to turn to the used car market at the exact moment rental car companies were scrambling to rebuild their fleets after selling off inventory to shore up their finances during last year’s lockdowns. It was a perfect, if temporary, storm.
Now, most of these contributions are waning. After slowing from 10.5% m/m in June to 0.2% in July, used car prices actually fell -1.5% in August.[ix] Hotel costs, which rose 6.8% in July, fell -3.3%.[x] Car rental prices, down -4.6% in July, fell another -8.5%.[xi] Food prices were a mixed bag, with most meat up and several other delicious goodies down, but the category overall moderated from 0.7% in July to 0.4%.[xii] The only category that got demonstrably worse was energy, which accelerated from 1.6% in July to 2.0% as gasoline prices jumped 2.8%.[xiii] The hurricanes hitting America’s south, which is home to many oil refineries, may see that stretch into next month’s prices, too, but that isn’t likely to last, either.
Because food and energy prices are subject to temporary disruptions that often have little to do with domestic economic conditions or money supply, analysts we follow often cut through the noise by looking at what statistics agencies call “core” inflation—prices excluding food and energy. Core CPI, which topped out at 0.9% m/m in April, rose just 0.1% in August—below its own long-term average of 0.3%.[xiv] Now, we aren’t arguing that outside of food and energy there was no inflation in America, which is a line of logic we saw getting a lot of laughs on Twitter. Anyone with Excel and a spot of cleverness can manufacture their own inflation index that magically comes out to zero. But we think below-average core inflation does suggest strongly that the factors driving American prices higher earlier this year are now firmly in the rearview.
This is not inherently bullish for equities—inflation doesn’t have a preset market impact. But we do think it offers a helpful preview for the UK, as it is a compelling example of inflation being more temporary than many financial commentators argued it would be earlier this year. In our view, America’s experience can help UK investors cut through today’s noise and take a more clear-headed view of price trends.
[i] Source: Office for National Statistics, as of 15/9/2021.
[iii] “Can’t Find Chicken Wings, Diapers or a New Car? Here’s a List of All the Shortages Hitting the Reopening Economy,” Juliana Kaplan and Grace Kay, Business Insider, 25/5/2021.
[iv] Source: FactSet, as of 14/9/2021.
[v] “Consumer Price Inflation, UK: August 2021,” Office for National Statistics, 15/9/2021.
[vi] See Note iv.
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