Personal Wealth Management / Market Analysis

Inside the UK’s Inflation Divergence

Localised issues kept inflation elevated, but in our view, those will likely fade in time.

Several developed economies released data measuring inflation (broadly rising prices across the economy) this week, with both Canada and the eurozone seeing their sharp inflation slowdown continue in March. On Tuesday, Statistics Canada reported the Consumer Price Index (CPI, a government-produced index tracking prices of commonly consumed goods and services) clocked in at 4.3% y/y, extending the improvement from last June’s 8.1% peak.[i] The eurozone’s final March estimate confirmed the flash reading at 6.9% y/y, continuing the trip down from October’s high of 10.6%.[ii] But the UK’s readings remain stubbornly higher, as March inflation remains lodged in double digits.[iii] Despite economists’ projections of a drop to 9.8% y/y from February’s 10.4%, it fell only half as much, hitting 10.1% in March—and down just one percentage point from October’s 11.1% peak.[iv] The path has also been more volatile, with a temporary reacceleration in February.[v] Fisher Investments’ research suggests stubborn inflation has contributed to particularly low sentiment across Britain. But there, too, improvement appears to be on the horizon, which could help propel stocks up the proverbial wall of worry bull markets (long periods of generally rising stock prices) are often said to climb.

In our view, the UK’s inflation divergence stems largely from energy policy. In Canada and the US, energy prices are market-set, leading to rapid improvement on the consumer front as wholesale fuel and power prices fell.[vi] Several European nations subsidised energy at the provider level, keeping the full cost increases from filtering through to consumer prices.[vii] Yes, the UK did too, but it also capped household energy prices.[viii]

The cap initially reset semiannually—every April and October—and Fisher Investments’ research finds it quickly became a price target. Accordingly, household energy costs have jumped in big stairstep increments every six months, and providers haven’t yet passed reduced wholesale costs to consumers.[ix] Further complicating matters, the government is paying the difference between its own price ceiling and the energy regulator’s cap, so households won’t start seeing a decline until the regulatory cap—currently at an average annual cost of £3,280—falls below the government’s £2,500 average annual cost ceiling … or until the government’s assistance expires in April 2024, whichever comes first.[x]

According to Fisher Investments’ research, the other big item boosting inflation—and the one stealing most attention from commentators we follow—is food. Food prices rose 19.6% y/y in March, the highest rate since data begin in 1989.[xi] That contrasts not only with the US, eurozone and Canada, where food price increases have started slowing, but also with global food commodity price indexes.[xii] Inevitably, headlines in publications we follow have pinned this on Brexit—arguing it limits import supply and raises shipping costs—and greedflation, which is a euphemism for the very normal practice of raising consumer prices, as and when demand allows, to preserve profit margins as costs rise. In our view and experience, this is a normal economic phenomenon and not price-gouging. In any case, based on our analysis, the causes appear more bland. One, supermarkets tend to lock in prices on long-term contracts. Hence, they are presently paying suppliers and farmers based on higher food commodity prices several months back.[xiii] As those contracts reset at lower prices, it should translate to cheaper meat, egg, dairy, grain and sugar prices (and lower prices of all the processed foods containing those inputs). Two, there are some localised supply issues, including an avian flu outbreak that affected egg supply and bad regional weather affecting produce and sugar beet harvests.[xiv] Three, industrial action has hampered transit of not just food, but packaging materials—another supply headache (not that we are passing any judgment on the strikes themselves).[xv]

In our view, all of these pressures are likely to ease soon. Warmer weather has already led to an increase in local dairy production, as cows can once again graze happily.[xvi] Falling global grain prices make livestock cheaper to feed.[xvii] The avian flu emergency has largely passed, returning free-range eggs to supermarket shelves.[xviii] Most food suppliers say the packaging cost pressures were a one-time thing and shouldn’t affect prices indefinitely.[xix] The much-discussed shortages of tomatoes and other fruit and veg are also reportedly easing as the local growing season kicks off in earnest.[xx] All signs point toward households getting some much-needed relief soon.

Once the food and energy kinks iron out, we think easing inflation will likely be much more apparent. The core inflation rate, which excludes food, energy, alcohol and tobacco, is much more in line with the rest of the developed world at 6.2% y/y.[xxi] As in other places, disinflationary monetary conditions are likely to foster further improvement. Broad money supply growth, at 3.0% y/y in February, is back at mid-2010s rates.[xxii] We recall many financial commentators warning inflation was too slow during this period. Even that 3.0% rate stems partly from the favourable comparison with money supply levels a year ago, as money supply has fallen in four of the past five months on a seasonally adjusted, month-over-month basis.[xxiii] Loan growth is also now negative at -0.3% y/y in February.[xxiv] It, too, is negative in four of the last five months on a seasonally adjusted basis.[xxv] We see this as an economic headwind, and it is one of the biggest reasons we remain on watch for a UK recession (a period of contracting economic output), but Fisher Investments’ research suggests it also combats inflation. Couple tighter monetary conditions with marked global supply chain and shipping improvement, and we see strong potential for prices to ease.[xxvi]

Fisher Investments’ research finds inflation doesn’t have a pre-set market impact, so we aren’t saying falling inflation is massively bullish in the UK or anywhere. But inflation appears to have hit sentiment hard, which we think contributed to last year’s stock market declines. So, in our view, it stands to reason that easing inflation should help reduce uncertainty—especially as it helps ease interest rate hike jitters. It may happen sporadically and at uneven rates globally, as the UK has shown, but overall, we think easing global inflation will likely alleviate one of the big items we think is weighing on investor sentiment. One less thing hanging over stocks.

[i] Source: FactSet, as of 19/4/2023.

[ii] Ibid.

[iii] Ibid.

[iv] Ibid.

[v] Ibid.

[vi] Source: FactSet, as of 19/4/2023. Statement based on inflation readings in the US and Canada, June 2022 – February 2023 and Brent crude and Henry Hub Natural Gas spot price in USD, 1/6/2022 – 28/2/2023.

[vii] “Europe’s Spend on Energy Crisis Nears 800 Billion Euros,” Kate Abnett, Reuters, 12/2/2023. Accessed via Yahoo! Finance.

[viii] Source: Ofgem, as of 19/4/2023.

[ix] Source: Office for National Statistics and FactSet, as of 19/4/2023. CPIH inflation rates for Electricity and Gas, monthly, October 2021 – March 2023 and NORX UK Power Daily Average, 31/10/2021 – 19/4/2023.

[x] Source: Ofgem, as of 19/4/2023.

[xi] Source: FactSet, as of 19/4/2023.

[xii] Source: FactSet, as of 19/4/2023. Statement based on S&P GSCI Agriculture Index, 31/12/2021 – 19/4/2023.

[xiii] “Why Are UK Food Prices Up By 19% – and Which Foods are Worst Affected?” Richard Partington, The Guardian, 19/4/2023.

[xiv] “Bird Flu: What Is It and What’s Behind the Outbreak?” Helen Briggs and Jeremy Howell, BBC, 17/4/2023.

[xv] “Strikes: Who is Taking Industrial Action in 2023 and When?” Staff, SkyNews, 31/3/2023.

[xvi] See note xiii.

[xvii] Source: FactSet, as of 19/4/2023. Statement based on S&P GSCI – Wheat price in USD, 17/5/2022 – 19/4/2023.

[xviii] “British Free Range Eggs to Start Returning to Supermarkets Soon as Curbs Lifted,” Joanna Partridge, The Guardian, 18/4/2023.

[xix] See note xiii.

[xx] “Inflation Eases But Still Remains Above 10% as Food Costs at 45-Year High,” Staff, SkyNews, 18/4/2023.

[xxi] See note i.

[xxii] Source: Bank of England, as of 19/4/2023. M4 money supply excluding intermediate other financial corporations (OFCs).

[xxiii] Ibid.

[xxiv]  Ibid. Sterling net lending to private sector excluding intermediate OFCs.

[xxv] Ibid.

[xxvi] Source: The Federal Reserve of New York, as of 19/4/2023. Global Supply Chain Pressure Index, December 2021 – March 2023.

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