UK : Deflationary forces intensify
Head of Macro Analysis
Summary: This is a rather quiet day on the European front as most investors are focusing on the upcoming FOMC meeting that will further explains the Fed's new strategy regarding inflation. In Europe, the most important data release was the UK CPI for the month of August which is down again, confirming that deflationary forces are intensifying in post-lockdown period. The direct consequence of lowflation is that it adds pressure for the Bank of England to widen its support to the economy as the risks of hard Brexit or thin deal (which is currently our best-case scenario) are looming.
In July, the official UK CPI figures surprised on the upside with the biggest driver being a strong rise in fuel prices (petrol and diesel) following a significant increase in demand as the UK and many other countries began to reopen their economies. In August, the UK CPI is down again, confirming that deflationary forces are intensifying in most countries in the wake of the pandemic. The CPI is down to 0.2%, which is the lowest level since the end of 2015, from 1% in the previous month, while core inflation is also down to 0.9% from 1.8% in July. The Eat Out to Help Out scheme implemented by the government to incentivize customers to eat in restaurants and other eating establishments by pushing down the cost of dining out remains the most important deflationary driver (it reduced the CPI by 0.5% on its own) along with airfares that felt for the first time on record in August.
In the short-term, inflation will likely stay subdued as the pandemic scars remain. Rising unemployment, which will probably increase much further in coming months as the furlough is coming to an end in October, will push households to cut their spending, thus putting increased downward pressure on prices. The lowest point for inflation in COVID-19 times has certainly been reached, but we are not getting out from prolonged lowflation anytime soon.
Contained inflation is also confirmed by expectations. In contrast to the post-2008 crisis, where 5Y index linked gilts moved briefly above 5%, currently inflation expectations remain stubbornly well-anchored, around 2%. This is pretty reassuring for MPC members that are worried about expectations. But it adds pressure for the Bank of England to act later this year to stimulate the economy as the risk of hard Brexit is looming. We still expect the Bank of England will widen the scope of its support, first resorting to QE and temporary financing of the government via the “Ways and Means Facility”. We don’t think that negative interest rates, which are part of the toolkit as stated for the first time by Governor Bailey in August, will be used as a first step due to the negative impact on the banking sector.
A gradual rebound in inflation is largely expected by market participants in 2021, when aggregate demand will fully recover and supply-demand imbalances will be reduced. The amplitude of the rebound will also be depend to a lesser extent on two other factors: the evolution of oil prices and any swings in the sterling pound due to the outcome of the UK/EU negotiations.
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Central banks' attempts to kill inflation is a paradigm shift, which could end in a deep recession.
Tangible assets and profitable growth are the winnersWith US equities officially in a bear market, the big question is where and when is the bottom in the current drawdown?
Understanding the lack of investment appetite among oil majorsThe everything rally seen in recent quarters has become more uneven, as its strength is driven by commodities in short supply.
The pressure is on as the wind leaves the sailsWith cryptocurrencies in sharp decline, are we entering a crypto winter or is the bear market a healthy clean-up of the crypto space?
Why the Fed can never catch up and what turns the US dollar lower?Many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve.
Bank of Japan: Swimming against the tideThe Japanese economy has gone from the age of deflation to rapidly rising prices in no time, leaving the Bank of Japan in a pickle.
Green transformation detour and bear market hibernationWith the impending risk of global econonomic derailment, we share the five things investors need to consider in this new half year.
Crisis redux for the eurozone?Whether there's going to be a recession in Europe or not, the path towards a stable economy will be agonizing.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)