If there's one thing that makes the process of investing decidedly complex, it's the constantly changing macroeconomic climate. This includes a number of individual aspects such as inflation and interest rates, and when combined they can have a cumulative impact on numerous assets and investment types.
Inflation is a particularly interesting macroeconomic factor, and one that tends to move independently to the value of the pound and the base interest rate.
Below Finance Monthly looks at the value of the pound against inflation during the course of the last 20 years or so, and ask how this should influence your investment choices in the near-term.
The Pound vs. Inflation – An Unbalanced Relationship
In simple terms, inflation has increased at a disproportionate rate to the pound over the course of the last two decades or more. More specifically, last years' prices were an estimated 303.3% higher than those recorded in 1980, meaning that 37 years ago £100 would have had the equivalent purchasing power of £403.34 in 2017.
Conversely, the pound itself has moved within a far narrower range during since the late 1980s and early 1990s, against a host of other major currencies. The GBP: USD has reached a peak 2.04 during this time, for example, while slumping to a low of 1.24 in January of last year. This trend is replicated across both the Australian Dollar and the Japanese Yen, while the pound has traded within an even more restricted range against the Euro since the 1990s.
From this, we can see that inflation and the cost of living has fluctuated far more noticeably than the underlying value of the pound, making it a particularly influence and volatile macroeconomic factor. This is an important point for investors to consider, as they must factor in the prevailing rate
of inflation and future forecasts to ensure that they build a viable trading portfolio.
Stocks vs. Bonds in the Current Macroeconomic Climate
To understand this further, let's compare the viability to stocks and bonds in the current, macroeconomic climate. In general terms, bonds are considered as more stable investment vehicles that are ideal for risk-averse investors, while stocks carry the burden of ownership for traders and are capable of delivering higher returns.
With inflation remaining high at around 3% in February (well beyond the Bank of England's target of 2%), however, bonds would appear to represent a better option in the current climate. This is because higher inflation can squeeze household incomes, lowering consumer confidence and spending in the process. As a result of this, both the economy and individual shares in the UK have the potential to be adversely affected in the short-term, while it's difficult to determine when inflation will return to a more manageable level.
Additionally, high inflation can also impact corporate profits through higher input cost, which can in turn lower share values and create negative sentiment within the stock market.
If this does happen, investors could well flock to defensive assets that are relatively risk-averse, particularly if inflation is expected to remain well above the BoE's 2% target throughout 2018. While further interest rate increases could reverse this trend, it's unlikely that the BoE will implement more than one hike this year if the current climate of uncertainty remains unchanged.
The Last Word
Of course, the economy and macroeconomic climate is a fluid entity, and one that could change considerably over the next few months.
Still, the spectre of high inflation is sure to be impacting on the decisions of investors and wealth management firms, as they look to diversify and optimise the returns of their clients in a challenging climate. This includes firms like W H Ireland, who are looking to build on recent growth and continue to thrive amid slower stock market activity and increasingly stained economic conditions.
So, while bonds may not be the most glamorous of asset classes, they offer genuine stability in the current marketplace.
Discussing the latest on stock markets, currencies and the news that Carillion will be heading into liquidation, Rebecca O’Keeffe, Head of Investment at interactive investor talks to Finance Monthly below.
The strength of sterling and the euro are seeing European stock markets fall slightly, as currency gains cap equity valuations. Sterling has been riding high both on the basis of a weaker US dollar and expectations of a softer Brexit than previously forecast. These currency moves are having a mixed effect on big corporates in the UK, where dollar weakness has given commodity prices a further boost with the big miners benefiting, while other big global companies are falling on the basis of lower dollar profits when converted back into sterling.
The government’s decision to walk away from Carillion appears to be based on optics rather than logic and looks like the wrong decision was made for the wrong reasons. There is no doubt that Carillion posed a huge political challenge for the government, which did not want to be seen to bail out another group of private shareholders and banks after suffering such a backlash from their decisions during the financial crisis. However, the prospect of the government temporarily funding existing Carillion public service contracts, alongside the likely increase in costs for renegotiating contracts with new suppliers, make it highly likely that they could ultimately pay far more than if they had provided the guarantees that Carillion’s creditors needed. It is far from clear at this stage what the wider implications will be from the liquidation of Carillion, both in terms of its impact on the construction industry and on the wider economy as a whole, not least from the enormous uncertainty that now afflicts the tens of thousands of Carillion staff and those other companies directly dependent upon it.
In June the UK’s inflation rate dropped unexpectedly to 2.6%, down from 2.9% in May. This comes as a surprise given the socio-political situation globally and in the UK, giving spout to the alarming degree of uncertainty businesses and the public are facing.
According to the Office of National Statistics (ONS), this was the first fall in inflation since October 2016, and was mostly due to lower petrol and diesel prices. Economists are now reportedly saying that this could cause the Bank of England to raise interest rates.
Below Finance Monthly has sought out several experts who could give their thoughts on the inflation fall, and what’s to be in months to come.
Markus Kuger, Senior Economist, Dun & Bradstreet:
The unexpected fall in the UK’s inflation rate is another sign of the economic uncertainty the country faces in the current political climate. Our analysis shows that the level of risk is ‘deteriorating’, with Brexit negotiations creating considerable unpredictability for businesses operating in and with the UK. This has only been intensified by the results of the general election in June, as the government’s narrow parliamentary majority is further complicating the process of leaving the EU.
Alongside the backdrop of an already slowing economy (the UK posted the lowest real GDP growth of all 28 EU economies in Q1 2017), a poll of business leaders after the election indicated a notable drop in business confidence. The best advice for businesses is to closely monitor the economic climate and the progress of EU negotiations, and use the latest data and analytics to assess risk and identify potential opportunities. As Brexit negotiations progress organisations should get a clearer picture of the future, but until then careful management of relationships with suppliers, customers, prospects and partners will be key to navigating through these uncertain times.
Kate Smith, Head of Pensions, Aegon:
Rapidly rising prices are almost always bad news for consumers, particularly pensioners on a fixed income, who are clearly having to go through a bit of belt tightening at the moment. The problem is amplified by both low wages and low interest rates, which give people little opportunity to grow their savings to meet the growing cost burden. There are lots of options available for people that want to diversify their investments outside of rock bottom savings account, but it’s important to plan ahead, and if dealing with significant amounts, consider seeking the input from a financial adviser.
Many of the younger generation seem to be prioritising current lifestyle over long term savings ambitions, and there’s nothing wrong with that in principle, but as inflation begins to bite it’s important they don’t start to see saving as an unaffordable luxury, and even consider sacrificing their workplace pension. By far the most effective means of saving is to do so early, and often, and there’s a risk that reducing regular contributions becomes a habit that’s hard to reverse.
Ranko Berich, Head of Market Analysis, Monex Europe:
Real wages remain in contraction and inflation is above target, but not above the BoE’s expectations. June’s inflation slowdown significantly reduces the chances of a near term rate hike as it vindicates the BoE’s last Inflation Report, and provides further fodder for the intensifying debate in the MPC about “looking through” the current inflationary shock.
The BoE’s last Inflation Report forecast inflation to peak around 3%, and this view remains intact after June’s CPI figures, although a marginal overshoot this year remains plausible. Although fuel prices were the main contributor to the slowdown, as a whole the release does not look immediately attributable to the sort of “transient factors” apparent in US inflation data, as several major basket categories made substantial negative contributions. Inflation in the UK is above target, but there’s nothing in June’s data to suggest an inflationary spiral of the sort that would entail an immediate rethink of monetary policy.
Sterling was looking rather frothy before the release, particularly against the greenback, and has been knocked down a notch as a result, as today’s release does reduce the likelihood of a hike in the immediate future. Thursday’s Retail Sales release will be crucial, unless consumer spending begins to recover from the shock seen in May it’s difficult to see how any of the centrist MPC members will be able to agree that policy normalisation is appropriate at any stage soon.
Edward Smythe, Economist, Positive Money:
While inflation may have fallen slightly in June due to lower fuel prices, it is likely that it will tick up back to 3% over the coming quarters. What should concern policymakers and businesses is that inflation is continuing to rise much faster than wages, which have only slightly improved in the decade since the financial crisis, putting pressure on households and forcing many on low incomes to rely on borrowing for everyday expenditure.
The Central Bank is in an increasingly difficult position. It may feel compelled to take action to meet the 2% inflation target, but raising interest rates could be catastrophic for an economy only growing weakly, and so reliant on personal borrowing and rising asset prices. This predicament highlights the need for policymakers to think seriously about new approaches to monetary policy which, unlike the current diet of quantitative easing and low interest rates, can help boost wages and reduce private debt.
Richard Flax, Chief Investment Officer, Moneyfarm:
With inflation at its highest level in nearly four years, you might expect that to increase the potential of an interest rate rise in the UK. But with wage inflation already lagging behind the latest Consumer Price Index (CPI), this isn’t necessarily a move that a lot of Brits could stomach. It’s now looking extremely unlikely that the Bank of England will increase interest rates in August.
Even if interest rates did rise, there is no way this could reach the levels that British savers are so desperate for, meaning those with excess savings sat in cash accounts should really start thinking about investing now to protect the value of their money over time. This is especially true for those saving for long-term goals such as retirement or helping their children through higher education. Millions of British savers could be in for a nasty surprise later in life if they find they can’t buy as much as they thought with their savings.
David Morrison, Senior Market Strategist, Spread Co.:
Sterling sold off sharply last week following the latest update on UK inflation. The headline Consumer Price Index (CPI) for June rose 2.6% when compared to the same period last year, and this was down sharply from +2.9% in May. Most of the decline could be blamed on a fall in oil prices and the British pound. However, inflation measures which exclude energy were also weaker, suggesting other factors were at play as well.
UK inflation has soared since the end of 2015 when year-on-year CPI was actually negative. Yet despite the pull-back last month it is still well above the Bank of England’s 2% target. Nevertheless, the consensus opinion seems to be that the pressure is now off the Bank to raise rates at next month’s key meeting. This is when the Bank’s Monetary Policy Committee (MPC) delivers its quarterly inflation report and is therefore a perfect opportunity to announce a change in monetary policy.
Before last week’s drop in inflation, many analysts expected a rate rise next month. For a start, there were a number of commentators who considered last year’s rate cut in the aftermath of the Brexit vote particularly ill-advised. Reversing it twelve months later would seem a sensible route to take.
This opinion gained traction after the MPC vote unexpectedly shifted from 7-1 against a rate cut to 3-5 in favour at their last meeting back in June. However, Governor Mark Carney is notoriously dovish, so he now has additional ammunition to urge caution from his colleagues next month. But the worry for Mr Carney and his dovish colleagues is that it’s dangerous to look at a single data point and extrapolate from it a change in trend.
If last weeks’ fall in inflation turns out to be a blip rather than the start of a steady decline, then it won’t take long for the Bank’s critics to accuse it of taking its eye off the ball.
Kerim Derhalli, CEO of invstr:
The UK has recently experienced a surge in inflationary pressure with, unsurprisingly, Brexit as the main culprit. As a nation, we love to consume foreign goods and the devaluation of the pound following last year’s referendum result made all of our imports more expensive. It also caused mayhem for economists and legislators looking to predict what is to come.
However, as the impact of this one-off devaluation event recedes, the inflation rate has started to level out and come down.
There are other economic factors too that are likely to put downward pressure on inflation. Wage growth has been lower than the overall level of inflation which has squeezed living standards forcing people to borrow more or spend less. Already low savings levels and high consumer debt suggest little capacity among Joe Public for higher prices. The uncertainty around the investment climate caused by Brexit has also impacted the housing market keeping both home prices and rents subdued. Outside of the UK, international energy prices continue to remain relatively low too helping to keep inflation in check.
What could change? One factor to consider is the current domestic political debate about higher domestic wage settlements in the public sector, which could help to drive up prices. Plus, as we learn more about the UK’s international standing in the world going forward, there are sure to be factors that economists haven’t even begun to consider that will throw their prediction models into disarray. Forecasting either growth or inflation rates is unlikely to get any easier anytime soon.
Jamie Smith-Thompson, Managing Director, Portafina:
Inflation is especially going to hit those pensioners with an annuity. Although there is an option to inflation proof an annuity when it is first taken out, most people decide not to factor it in because the benefit leads to such a reduction in income in initial retirement. Consequently, the majority of pensioners with an annuity will be on a a fixed income. The knock-on effect is as inflation increases, their purchasing power reduces. The longer you are in retirement the less money you will tend to have in real terms and sadly it is in later retirement when that money is needed for care and support. This is all a powerful reason why it is important that the triple lock remains on the state pension to provide some degree of protection.
One of the key questions people ask themselves as they consider their retirement is “How am I going to take the income?” and inflation and death benefits should be a primary factor to bear in mind when looking at what’s out there. The two primary options are drawdown or annuitys. If you want to factor in inflation-proofing into your annuity you could reduce your initial pension income by around 30%. Apart from the huge reduction itself, it is an unattractive proposition because most people are more likely to need greater income in the initial part of retirement, as this is when they are more active. For this reason, annuities are not as popular as they once were. Drawdown on the other hand takes inflation into account by default. Drawdown remains invested so if inflation goes up, the markets usually go up as well. It is far more flexible and it allows the owner much more control in terms of the state of the economy.
Adrian Slack, Senior Trader, Learn to Trade:
Since the UK's vote to leave the EU last year, the value of the pound has continued to depreciate. This stimulated an increase in the cost of imported goods and raw materials prompting an increase in inflation.
As the value of sterling continues to fall, households should expect to feel the pinch of higher costs on everyday imported goods in their baskets and on European holidays. Businesses should also expect to incur higher costs for doing business in Europe – they need to plan carefully when buying goods from overseas to lessen the blow on a potential fall in business profits. Exporters will continue to benefit as sterling’s fall makes UK goods more competitive overseas.
Moving forward, we expect inflation rates to creep back up steadily due to sterling’s continued weakness due to political risks resulting in higher import costs and fundamentally increases in prices to purchase. Whether this leads to a rise in interest rates is still to be confirmed. There’s an entire generation on low mortgage rates and so any increase in interest rates will have a negative effect on the housing market. We are in a bit of a catch 22 at the moment. With Brexit negotiations underway, it’s difficult to say how high inflation rates are likely to go.
Ana Boata, Economist for Europe, Euler Hermes:
June’s lower-than-expected inflation rate is mainly due to base effects linked to the summer discounting of some goods’ prices and the appreciation of the Sterling in April and May. These effects should already fade away in July and we expect the inflation rate to approach but remain below 3.0% year-on-year this autumn.
Looking towards 2018, the growing economic uncertainty surrounding Brexit will continue to hamper sterling. Increasing import costs will continue to put upward pressure on inflation, which will hit 2.7% on average in 2017 and 2.6% in 2018. This will act as a drag on consumer confidence and trigger a significant slowdown in consumer spending growth to 1.9% (from 2.8% in 2016) and 1.2% respectively.
GDP growth is expected to slow down to 1.4% in 2017 and 1.0% in 2018 which, coupled with the weakness of Sterling and the rise in inflation, would argue for a smooth rate hike in H2. This should support households’ real purchasing power and help avoid a sharp adjustment of the residential housing market.
From 2019, the level of inflation will be heavily influenced by the UK’s trading relationship with Europe. We forecast that a transition deal – where the Single Market conditions would still be kept for defined period of time – is the most likely outcome. This should be seen as a good news and help Sterling stabilise somewhat. Inflation should moderate slightly to 2.4% in 2019 and 2.3% in 2020. Without a transition deal, inflation would likely reach a high level of 3.5% in both of those years.
High levels of competition, increasing discounter market share and an online shopping frequency more than twice the European average have already made the UK retail sector of the most challenging in the world. In addition, growing financial stress, highlighted by a 10pp increase in net gearing ratios last year with average profits (EBIT) slipping by 1.4pp to 5.6%, is expected to place greater pressure on cash flow and payment terms throughout the retail supply chain.
Salvador Amico, Partner and head of the Brexit team, Menzies LLP:
The fall in the rate of inflation has come as a surprise but businesses, consumers and the Bank of England alike are unlikely to be celebrating too much at this stage.
Future economic and market-driven volatility is still expected. Inflation rates could creep back up and the pound will remain volatile, hindering long-term investment plans. To avoid losing out, businesses should take steps to minimise their exposure to such volatility by re-assessing their supply contracts, distribution networks and hedging against currency fluctuations.
To date, there has been a reluctance from businesses to pass on extra costs to the consumer in the form of price rises, but this could become harder to avoid in future. In the meantime, businesses will remain focused on removing cost where it is possible to do so by renegotiating contracts and relocating supply chains closer to home.
Inflation rate fluctuations are usually an indicator that change is on the horizon and speculation over whether the Bank of England is likely to raise interest rates in the coming months will also be causing concern. However, with consumers being squeezed on a number of levels and wage inflation continuing to lag, it would be surprising if interest rates rose before the end of the year. With the economy hugely dependent on consumer spending, taking disposable income out of their hands would be counterproductive.
One of the key challenges facing businesses at the moment is exchange rate volatility. By now, the impact of recent falls in the value of the pound have worked their way through the system and this could mean that the economy is starting to stabilise.
This has been a year of curveballs and, as we have seen, it can take just one shock change to unsettle the entire business community. For the time being, however, inflation rates appear to be moving in the right direction and we should be grateful for that, even if we know it is unlikely to last.”
We would also love to hear more of Your Thoughts on this, so feel free to comment below and tell us what you think!
With socio-political uncertainty reigning the decisions of businesses and banks, currency fluctuation is unpredictable and both the USD and GBP have been undergoing copius periods of pressure. Here Bodhi Ganguli, Lead Economist at Dun & Bradstreet gives Finance Monthly an updated run down on the currencies and their status moving forward.
An investigation of the movements in the dollar-pound exchange rate needs to balance short run fluctuations against the medium to long term fundamentals. While day-to-day volatility in the currencies can produce financial gains for a subset of finance professionals like currency traders, the underlying trends in the exchange rate are far more important for the overall growth of the two economies, and eventually of more significance to businesses.
Note that the USD-GBP exchange rate is a “relative price”, or in other words, it is the price of one currency in terms of the other currency. As such, all movements in the exchange rate are relative to each other. Therefore, factors that have an impact on either the USD only, or the GBP only, will end up producing fluctuations in the exchange rate. The latest phase of weakening in the GBP relative to the USD began in earnest after the Brexit referendum in June 2016. The UK’s decision to exit the EU was seen as detrimental to growth in the near to medium term, causing erosion of investor confidence in the GBP. The immediate reaction was a slump in the relative price of the GBP; in less than a month the value of the GBP fell from USD1.45 to USD1.30 or nearly an 11% depreciation in the sterling. Since then, the GBP has lost even more ground vis-à-vis the USD.
The USD’s behavior over the last couple of years was also a factor behind the post-Brexit slump in the GBP. The drop in the pound happened to coincide with one of the strongest phases of the dollar in recent history. Against the currencies of a broad group of major US trading partners, the USD started appreciating sharply and steadily in mid-2014, and by the time of the Brexit vote in June 2016, it was already 18% stronger compared with July 2014. Since then, the USD gained even more thanks to investor optimism following the election of the Trump government.
More recent trends in the USD and GBP offer clues to the near-term movement of the exchange rate. The pound will remain under pressure during the course of the Brexit negotiations that have just commenced primarily because there is significant uncertainty associated with them. Brexit remains a systemic risk that will weigh on growth in the near term. More importantly, investor sentiment will be subject to frequent changes until Brexit is complete and any perceived increase in risks will weigh on the pound. This will tilt the exchange rate in favor of the USD, also, partly because the USD is a safe haven currency that investors flock to whenever there is an increase in geopolitical uncertainty. Over the longer run, we expect the pound to weaken modestly against the euro (the currency of the UK's most important trading partner) until 2021, but this assessment assumes that elections on the continent will be won by pro-European parties and the Greek debt crisis will not return. Against the dollar, a very modest strengthening should set in towards the tail end of this decade but political risk in the wake of the Brexit negotiations has the potential to impact on the exchange rate. In any case, currency volatility will be a bigger issue than in previous years, also caused by political events on both sides of the Atlantic and the Channel.
Monetary policy in the two countries will also be a driver. The US Federal Reserve has already started the process of monetary policy normalization—the only major western central bank that has started raising interest rates from the ultra-accommodative lows necessitated by the Great Recession. On the other hand, the Bank of England launched the latest round of monetary stimulus right after the Brexit referendum and continues to support the economy with record low interest rates. The spread between the US and UK interest rates will also favor the USD, although the USD has its own issues to worry about there. Following the latest rate hike by the Fed in mid-June, the dollar remained relatively subdued. There are two main reasons why the link between a Fed rate hike and dollar appreciation seems broken for now: one, investors are assigning a low probability to aggressive rate hikes by the Fed given the recent weakness in US inflation data, and secondly, while investor optimism is still there, it is now widely accepted that the Trump administration’s fiscal policy measures, like tax reform and deregulation, will not add to US growth in 2017. In fact, implementation risk remains high given the level of disagreement on key issues among Congressional Republicans.
Ironically, while currency weakness fundamentally signals weakness in a country’s economic prospects over the longer run, it could benefit an economy in the short run. This is clearly evident from the gains in manufacturing seen in the UK, thanks to the weakness of the pound. However, there are downside risks from the weak pound, like rising inflation, which will weigh on consumers and prompt the BoE to raise rates. Similarly, no one seems to mind the lackluster reaction of the USD to the Fed rate hike. Manufacturing benefits, corporate profits gain, and even the Fed might not be too worried as the weak dollar will boost inflation and help it stay on track to raise rates. Eventually, of course, economic fundamentals will take over and the exchange rate will reflect the varying economic prospects of the two countries.
Oanda Senior Market Analyst Craig Erlam believes the GBP exchange rate depends on how the Brexit talks unfold and the political situation in the UK. Erlam says the US dollar is heavily sold and due for correction. He expects EUR/USD to revisit 1.10 handle.
Watch the full segment as Erlam details the key technical levels on the major pairs - EUR/USD, GBP/JPY and GBP/USD.
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At the current rate of fluctuation, with socio-political uncertainty reeking chaos in the markets, the pound’s performance leaves little to desire. Currency experts are now warning that further in 2017 we could see the pound hitting the same value as the euro.
According to the Sun, analysts have advised towards this possible plunge due to the general election, which resulted in a hung parliament, and the closing on the Brexit deadline.
Holidaymakers that are worried about the potential currency volatility ahead are being told to buy half their currency now and half closer to their break, as the pound could even break below the euro.
Finance Monthly has heard Your Thoughts on the possibility of a British value parity with the euro and included a few of your comments below.
Jonathan Watson, Chief Market Analyst, Foreign Currency Direct:
The prospect of the GBP/EUR exchange rate reaching parity or 1 GBP = 1 EUR has been raised many times over the course of recent events, before and after the Referendum vote. Throughout 2017 analysts have been split as to which direction rates will take, I believe there are two key features which explain why we are here and which will ultimately shape the likelihood of it being achieved.
Parity was almost reached in December 2008 when GBP/EUR hit 1.0227, since then the July 2015 high of 1.4345 had seemed to indicate such lower levels were confined to history. However, since 2016 and the result of the EU Referendum, politics has become the big driver on Sterling. Political concerns too have reached Europe and the failure of Le Pen and Gert Wilders to win any victory has seen the Euro strengthen. There is a German election in September and potentially an Italian vote too to be called in September, but, for now it seems the Euro has survived and this has helped it gain against the politically scarred Pound.
Economic data is the second factor and here too we see the Eurozone outshining the UK growing 0.5% in Q1 2017 against the 0.2% for the UK. Divergence in monetary policy is also key as the UK and the Bank of England could potentially raise interest rates to combat rising Inflation, threatening consumer spending and lowering GDP. Meanwhile the European Central Bank are looking to withdraw stimulus and maybe raise interest rates in the future, helping to further boost the positive sentiments towards the Euro.
Ultimately the prospect of parity is not going away and the outcome of the UK election is vital to determining how likely, as it effects who is on the UK side of negotiations with the EU and how strong their mandate is.
We are only 2 months into the Article 50 window and just coming up to the one year anniversary of the vote on the 23rd June. We have in the grand scheme of history just begun on this path and looking at what is ahead the prospect of parity for GBP/EUR this year remains a very real possibility.
Owain Walters, CEO, Frontierpay:
Ahead of the election, some analysts warned that the value of sterling will reach just £1 to €1. The political uncertainty following the election hasn’t eased the short-term risks to the Pound. However, I would argue that this result will, in the long term, be good news for sterling.
What I believe we will see next, as the Conservatives are forced to form a coalition with the DUP, is that Theresa May’s plan for a ‘hard Brexit’ will be diluted, if not taken off the table entirely. Since the vote to leave the European Union last year, the currency market has, on the whole, not responded well to the dialogue around a “Hard Brexit” and with the influence of a more liberal party in a new coalition government, the idea of a ‘softer’ Brexit will provide support to the Pound and we will see a period of strength.
The significant losses that the SNP has seen will also reduce the chances of a second Scottish independence referendum. While the notion of another Scottish referendum hasn’t done irreparable damage to the pound, taking it off the table at least for the foreseeable future will certainly give the Pound an extra boost.
Patrick Leahy, CFO, JML:
If the political events of the last two years have shown us anything, it is that situations that are improbable are certainly not impossible. Sterling/euro – or even sterling/dollar – parity is not out of the question. Whether you are an importer or exporter of goods or currency, CFOs across the country would rather the whole thing settled down and we had some certainty; but that’s unlikely. So what can you do?
Being in the FMCG market, JML’s short-term retail price is fixed, and it takes a good year to adjust prices. Just look at the large drop in sterling, post Brexit; it is only now that the inflation effect is really starting to trickle through to business and consumers. So, as a CFO with no concrete forecast on what will happen with the rates, you must try to minimise the impact any movement has on your pricing and margin strategy.
As a net importer, UK businesses and especially retailers are always susceptible to falls in rate, pushing up our costs, reducing margins, or lowering volumes. In some ways, the best strategy any business can have to manage exchange risks is to sell to other parts of the world – it’s a natural hedge. But, it is not that simple, because margins in each country are important and you can’t always point to your exchange gains when discussing gross profits with your invoice discount provider.
For retailers, the key is to not overstretch yourself if hedging on currency movement. Regularly and accurately forecasting your business performance is key to achieving this. It’s impossible to know exactly what your currency requirements are in 12 months’ time, but you know you will have some. You might win and lose on currency movements along the way but by slowly building your hedged positions you will have minimised the risks and helped the business achieve its margin along the way.
We would also love to hear more of Your Thoughts on this, so feel free to comment below and tell us what you think!
The Consumer Prices Index (CPI) recently measured annual inflation at 1.8% in January, which is 1.6% rise since December’s figure. This represents the fourth consecutive that the inflation rate has seen a rise, and the highest in over two and half years, since June 2014.
Alongside this, according to the RAC, fuel prices hit a two year high this month, while on the other hand the prices of clothes and trainers have fallen compared to this time last year. So, what’s happening with the UK’s economy, and why is the country’s inflation rate pumping month on month?
Below we’ve heard comments from a number of economy specialists and market analysts, who have given their say on the latest inflation rise.
Jonathan Watson, Chief Analyst, Currencies:
I believe Inflation is going to continue to present a problem in 2017 as the weaker pound continues to put pressure on raw material and fuel costs for business and consumers. The UK as a net importer relies on buying more from overseas than it sells to the rest of the world. Whilst the recent bout of sterling weakness has made UK goods much cheaper to foreign investors, as the weaker pound and higher inflation gently feeds into the economy the longer term effects are less beneficial.
The pound has fallen some 15-20% against most currencies since the Referendum result in June 2016. With the UK relying on imports of raw materials from overseas the rising price of certain goods is now feeding into a higher Inflation rate for the UK. The reason the effects of this have taken time is because many businesses that buy goods from overseas will have fixed the price many months before the goods were physically purchased. As time goes on and the pound remains weaker against its counterparts the price for companies to buy raw materials from overseas will be lower meaning for them to remain profitable they must raise prices.
The price of Oil is a key factor in all of this since the price of Oil was almost 50% less this time last year. The fact the price of Oil is priced in US dollars doesn't help since the pound has recently been trading at close to 31 year lows against the greenback. A high Oil price affects business and consumers by raising fuel costs. The price of fuel is a large part of many consumers and business fixed costs so increases have a wife effect across the economy.
With Brexit negotiations likely to commence in the coming weeks and there remaining huge uncertainty over what to expect I expect sterling will come under further pressure pushing Inflation higher again. The coming months will also see many businesses importing from overseas needing to renew their contracts fixed last year when the pound was stronger. These new contracts will be more expensive as sterling is weaker leading to a prolonged period of higher inflation as businesses seek to remain profitable.
As we are seeing with the recent trends Inflation rising in inescapable given the economic conditions. Whilst sterling has found some better ground as we have some certainty over the commencing of Brexit I feel there is a long way to go before the pound will be strong enough to make up for the effects on the rate of Inflation, some of which are still to be felt in the coming months. Businesses looking to buy goods from overseas should be planning carefully their future contracts to mitigate for further sterling weakness.
Professor Martin Walker, Professor of Finance and Accounting, Alliance Manchester Business School:
Today’s news about inflation increasing to 1.8% comes as no surprise. Given the very significant fall in the pound following Brexit the costs of imported materials, especially fuel, were bound to rise. Moreover, it is likely that inflation will continue to rise as increased costs continue to feed through to retail prices.
It is difficult to predict just how high inflation will go, but we are potentially looking at a peak value between 3.1 and 3.8 percent, probably around the end of 2017. It is also likely that the peak inflation rate will be substantially greater than pay rises, so real wages will fall a bit on average. This is likely to reduce consumer demand and, as a result, the growth rate in the last half of 2017 and the first half of 2018 is likely to be lower than it would have been in the absence of Brexit. Inflation is likely to start to fall during 2018.
What happens to the UK economy after 2017 is anybody’s guess. It will depend on how well the negotiations on Brexit proceed and also on news about new trade deals after Brexit in 2019. One particular issue that we all need to keep a close eye on, is the potential impact of Brexit on investment by overseas companies in the UK. If this does not decline then it will bode well for the long term. However, if it goes into a sharp decline then Brexit will start to look like a failure.
The only thing we know for certain is that Brexit has increased economic and political uncertainty both for the UK and for Europe as a whole.
Conor Murphy, CEO, Smartr365:
Annual inflation rising to its highest figure since June 2014 was an inevitable consequence of the devaluation in sterling over the past eight months following the Brexit vote.
Generally speaking, there has been a downbeat feeling for some time that inflation will steadily worsen, but I don’t completely agree and prefer to adopt a more positive outlook.
Though the figure released by the Office for National Statistics rose from 1.6% to 1.8%, this is still less than it was expected to be at this stage and I feel that while it is an issue, it is perhaps not as big an issue as it was forecast to be – so the outlook is not entirely gloomy.
That said, should the Pound drop again following the notification of Article 50, then thus would inevitably create further inflationary pressures. Time alone will tell and even financial experts cannot predict the future with certainty.
In my opinion, I feel that the worst/hardest Brexit possible is already priced in and – allowing for temporary fluctuations – I do not think the Pound will weaken further - if anything, I feel it will start to strengthen at some point,
The bottom line is that inflation may well pick up further, but I don’t think it will massively overshoot the 2% target and therefore it is not the end of the world!
In summary, I feel people should expect, and also get used to, slightly increasing prices, but largely offset by salary increases which are still keeping pace – or in many cases exceeding – the rate of inflation.
In a world where people and financial experts tend to err on the side of caution – with good reason – I admit I have a much more optimistic take on the future and prefer to always expect the best rather than the worst.
Charles Fletcher, Head of Analysis, Cogress:
After Brexit, there was an inevitably sharp slump in the value of the pound. This became one of the catalysts for the rise in inflation that we are seeing now. The weakened pound instantly affected imports and consequently, raw materials and goods became more expensive to buy with sterling. The upturn in price pressure forced shops to raise their prices, where consumers saw the cost of everyday products like Marmite increase by up to 10%.
As household incomes feel the pinch of higher living costs, accompanied by an uncertain job market, we are seeing signs of the property market softening. There is a strong connection between (rising) inflation rates and property prices. Some property owners may be excited by the price increase on their home, but when this is accompanied by rising inflation the real increase is negligible. This is because of the growing cost of building materials. If the price to build goes up, less properties will be built, which directly impacts the market’s levels of supply and demand. Not to mention the correlation between interest rates and inflation, whereby if less mortgages are taken out that means less people are getting on the property ladder.
‘Caution’ may still be the operative word to describe the property market for many economists and property researchers, but we are still seeing banks lending, developers building and buyers purchasing homes. Nationwide predicts price growth of 2% for 2017, which is higher than most, despite it being more than half of 4.5% growth last year. The key point is that now, while the top end of the market (£1m+ homes) has taken a hit in both price and transaction levels, the <£1m market has soldiered on admirably amidst rising inflation rates and Brexit. Therefore, the tale of the UK vs. London property market (or even Slough versus Chelsea) will tell two very different stories, especially for how inflation will affect those consumers and their behaviour.
Ranko Berich, Head of Market Analysis, Monex Europe:
Low inflation and strong consumer spending have been two of the dominant features of the UK economy in recent years, driving GDP growth to exceed the Bank of England’s expectations during the post-Brexit vote period. But sterling’s sharp fall in the wake of the EU referendum has set the UK on an inflationary path, while at the same time consumers have dialled back spending sharply.
We’ve yet to see the bulk of the inflation expected in 2017 due to past depreciation in sterling. For example, inflation in food items is only just beginning to pick up due to cutthroat competition in the supermarket sector. Recent survey data also points towards surging input costs for manufacturers. So, despite January’s year on year CPI inflation being the highest since 2014, we’re likely to see even higher figures in the near future.
How the consumer reacts is crucial. The fall in consumer spending in the three months to January was the first since 2013, but it’s a volatile data series and the move could simply be a small pullback after a long, steady upwards trend. However, the timing coincides with an increase in average store prices, suggesting that as prices continue to rise consumers will keep dialling back, potentially resulting in a significant GDP slowdown in 2017.
The UK economy has indeed exceeded almost all expectations for the post-referendum period, resulting in criticism of the Bank of England’s alarming forecasts. But with inflation beginning to bite and a big question mark hanging over the direction of consumer spending, the UK economy could lose the underwrite it has long enjoyed from a strong consumer. The BoE’s initially dire predictions could ultimately be proved correct.
Owain Walters, CEO, Frontierpay:
The data shows a mixed picture, with consumer inflation coming in slightly below market expectations (1.8% vs. 1.9% expected), while manufacturing prices show a slightly higher inflation than expected. This would indicate to us that a further rise in inflation is due, as the rising costs of goods are still to fully filter through to the consumer. However, whilst it is currently popular to panic about the economic data in the wake of the Brexit vote, we would point out that inflation is still below the Bank of England’s 2% target and the current rise in inflation is a one-off event due to the devaluation of Sterling. The markets expectations have been dashed this morning and as a result the Pound has lost about 1 cent to the US Dollar and about 0.8 cents to the Euro.
We would also love to hear more of Your Thoughts on this, so feel free to comment below and tell us what you think!
Sterling has encountered significant losses in recent days with the increasing support for anti-EU theme from the recent ORB polls conducted regarding the referendum. More than 55% of voters showed their support for leaving EU while only 45% were interested in staying back with EU. The important point to note here is that price action has been driven mostly by change in market sentiments based on results from poll data. The volatility of GBP has consequently increased since the announcement of referendum and has dropped to its lowest levels as last seen in 2008.
GBP has been performing very bad especially against dollar and GBP/USD reached its all-time-low level of around 1.39 during the month of February 2016. It was the time when initial talks about referendum came into picture that caused huge fears among the investors regarding the financial instability of UK. Based on technical analysis from the options market, there is 72 percent chance of GBP/USD pair trading anywhere between 1.32 and 1.51, by June 24th once the results of the referendum are announced. The GBP/EUR exchange rate is meanwhile expected to range between 1.33-1.35 after the voting.
The topic of British Exit from Europe has been discussed for years and became popular during February 2016 after Prime Minister David Cameron promised to conduct a voting for the same by June. Though voting will be held on June 23rd, it will not result in immediate departure of UK from the European Union. It would commence a multi-year negotiation period on the terms for exiting EU. Based on polls conducted during last few months, there has been mixed results on the majority’s bias with some polls showing minor leads on either side. The below table from Wikipedia shows the results of various polls conducted regarding the referendum,
|31 May - 3 June
|30 - 31 May
|27 - 29 May
|25 - 29 May
Britain has always remained a semi-detached member of European Union and most of the British bureaucrats believe that they can do better alone. Some of them are frustrated by the fact that EU gets benefited more from the UK than UK from the EU. The recent economic problems of some EU members like Greece have caused huge disinterest regarding the EU membership among British investors. Though pound has decreased significantly against USD and the trading is done based on shifting expectations for the referendum, GBP/EUR is showing a longer-than-average bullish day’s range as of June 15th, which is giving a positive outlook for trading GBP. It is an early sign for positive impact on GBP in the currency market, after the steep decline experienced in recent days. The important fact to note here is that Brexit will not only affect GBP, but also Euro.
Based on certain analysis reports, UK leaving the EU could result in loss of more than 950, 000 jobs by 2020 and deficit around £100 billion which is around 5% of their GDP. When looking at possible impacts for each decision, it is important to note that whatever significant ground lost in recent days is likely to be made up relatively fast once the business gets usual after the referendum. But even before voting, many investors are selling GBP as risks are associated more with the decision. If we look at the current account deficit of UK, it clearly indicates that GBP is becoming weaker. UK has a current account deficit of more than 5 times its GDP, which is the worst for any developed nation making this a strong reason for sterling’s weakness in currency market. In the coming days closer to referendum, we can expect to see sterling respond less to economic reports of UK and trade based on Brexit-related updates.
Any pro-Brexit pool can result in further decline of GBP and anti-Brexit news could cause an upward trend on GBP. If the Brexit vote becomes positive and pound hits the lows, it will be a good time to buy GBP as it will definitely bounce back after some time. The Bank of England might come for rescue by announcing interest rate hike to generate a positive sentiment among the investors. Euro will also face downward pressure, if the Brexit vote becomes positive and is already witnessing some volatility based on the poll results. Trading GBP amid this volatility is a risky affair for currency traders since none of us have a crystal ball. Since the vote is currently too close to call, it might be sensible to lighten up your exposure ahead of the referendum.