Tuesday is pretty quiet on the data front although the UK faced the usual monthly raft of inflation data.
The Bank of England looks to be caught between a rock and a hard place as it tries to wend its way between the realities of a soft pound with all the follow-throughs that affect an economy addicted to importing goods it doesn’t need, paid for by money it hasn’t got.
Conventional economics of the 1.0.1 variety would have it that the rise in the price of imported goods prompted by the weaker currency would by osmosis drive a natural slowdown in demand. In an “I want it and I want it now” society, the price differential is parked on the credit card, another issue to be dealt with at some other time. Eventually, in an over-borrowed consumption-driven system the central bank finds itself faced with the horrible choice of either pushing rates higher, which in turn might slow demand but at the same time push the economy into a declining spiral of either rising unemployment followed by increasing consumer debt default, or of increasing consumer debt default followed by rising unemployment.
In reality it’s not quite so simple. Many of the interplays between input factors into the economic model have been overhauled and outdated by globalisation and watching national central banks struggling away trying to make head or tail of the impact of their monetary policy can be quite depressing. The UK still runs two parallel inflation numbers, namely the old RPI as well as the more current CPI measure.
Basket case
Both RPI and CPI measure inflation by taking a basket of goods – they do not use the same basket though - looking at what they cost last year, looking at what they cost now, and finding the proportional difference.
CPI leaves the cost of housing out of the basket – so rises in mortgage payments, rents, and council tax aren’t reflected - but RPI takes account of those costs. There is a mathematical difference as well. The RPI calculates its ‘proportional difference’ using the arithmetical mean between the old price and the new; the CPI uses the geometric mean. The end result is that the RPI almost always results in a higher figure for inflation than the CPI. Over the years the government has been busily replacing RPI-linked payments with CPI-linked ones but there is still enough on the Westminster expenditure slate that is tied to RPI, and that was 3.5% from a forecast reading of 3.7%. CPI at 2.6% was milder than the forecast 2.9%.
Still, the Bank must feel enormously tempted to move above its 0.25% key interest rate but with the uncertainties emanating from the confused Brexit negotiations ringing in its ears it seems unlikely that it will find the courage to report anything other than vigorous debate and a few dissenting votes in MPC meetings.
So while the Bank of England wrestles with the problem of how not to tighten monetary policy in light of 2.6% CPI and negative real returns across the entire Gilts curve the Fed continues to face the opposite, namely a desire to normalise the interest rate structure while faced with a manifest absence of meaningful inflation.
Steering committee
In a global economy inflation can grow in one place, thrive in another and find a completely different area to go to seed. There is little doubt that our central bankers, none of them exactly intellectual slouches, have worked this out for themselves but they have been handed a toolbox that was kitted out when the complex of problems was not only different but, to coin a phrase, a lot less complex. More to the point, the monetary authorities are now no longer expected to simply help manage and mitigate the effects of the economic cycles but to actually steer them.
Coming back to the levels of household indebtedness, especially in this country, the dependence on credit for economic growth and a tightening of credit conditions leads to an accelerated slowdown that is hard to predict and even harder to control, once it sets in. This is what causes the UK’s extremely pronounced boom and bust cycles, which the invisible Scotsman rather rashly claimed to have abolished. Conclusion: UK inflation can do whatever it likes, ultimately it will not be permitted to affect the way in which monetary policy is decided…which in itself makes a total mockery of monetary policy per se.
For international investors, the UK remains a case of lighting the blue touch paper and withdrawing. For UK domestics it is about lighting the blue touch paper and staying there.
Swamp thing
Meanwhile back in the US of A the O’Bamacare Assassination Act has hit the skids with senators Moran and Lee joining senators Paul and Collins on the “nay” side of the lobby, effectively killing off any hope President Trump might have had of pushing through his key election promise to repeal and replace. The swamp is fighting back. So far Trump ‘s record on reforming and reshaping the nation in his image is far from glorious.
Whether markets will react to the failure of the healthcare reform with its implications for cost savings and a redirection of resources – or lack thereof - into much vaunted infrastructure spending is yet to be seen. The earnings season rolls on with Netflix having blown away all forecasts with massive subscriber growth and a 9% post-market jump in its stock price. More seriously, Goldies and Bank of America are on today’s docket.
As earnings are reported and black-outs end, corporate issuance should be quite lively with blue-chip names competing to strap down cheap cash while the going is good. Investors will have a rare opportunity to be selective and send pricing messages to issuers….although I can’t see many of them doing so.