Author: Daniel Terry

As recently as last week, core inflation (excludes energy and food prices) in both the Eurozone and the United States was easing slightly, whilst in the United Kingdom inflation remained 8.7%, but core inflation increased to 7.1%, the highest since 1992. So why is it when the United States and the Eurozone get a drop off in core inflation, Great Britain suffers an increase?

Without a doubt all Remainers blame Brexit for the inflation problems with the ex-governor of the Bank of England, Canadian Mark Carney, being their standard-bearer. The fall in the pound after Brexit is usually trumpeted as a reason for inflation, but that was seven years ago, and since then, sterling, apart from the odd blip (the Liz Truss regime stands out), has remained relatively steady and in 2023 has gained in strength.

Other reasons from the Remainers camp is trade with Europe is now more expensive and difficult with the end result being costlier imports. The lack of access to labour and skilled workers from Europe is yet another reason put forward by Remainers, but with immigration actually having increased this argument is redundant. However, it cannot be denied that leaving Europe has contributed to the weakness in business investment, but is that a contributing factor to an increase in inflation? Probably not.

The Bank of England has received many derogatory comments regarding the increase in core inflation, and it is argued that their attitude towards inflation was lethargic, and they are therefore responsible for the problems that beset the nation today. Blaming the Bank of England is the easy way out, and they have acted in concert with many other central banks throughout the world. In fact, they were the first to raise interest rates.

Experts suggest that there are a number of influential factors responsible for the increase in core inflation and these can be seen in;

1. Pay Inflation – The United States is running at 4.3% and the Eurozone is running at 5.2%, whilst in the United Kingdom it is running at 7.2%, helped along by increasing the National Living Wage in 2022 by 6.5% and by 9.7% a year later.

2. Supply Performance – The United Kingdom is suffering from a poor supply performance, and as opposed to other G7 countries their GDP is still well below pre-Covid-19 levels.

3. Workforce – There has been a massive fall-off in the workforce, with Covid being the major instigator of this scenario, but Covid was a global shock that has left its mark and can take some responsibility for where the United Kingdom (and many other countries) are today.

The United Kingdom is not alone in fighting inflation, and according to experts, the root cause of the massive increase in global inflation is found in a series of supply shocks, resulting in higher prices and the probability of a wage – price spiral. Central Banks would have to use monetary policy to fight this spiral, with the end result of bringing down inflation and hopefully wages. 

Sadly, the United Kingdom was hit particularly badly as the supply situation was much more severe than many other countries, and this is the real criticism of the Bank of England, as they did not act quick enough to keep the lid on the wage – price spiral.

There is only one monetary supply policy available to the Bank of England, and if increasing interest rates is the only way to fight inflation, the United Kingdom may well fall into recession. It will be painful, but we can only hope the current policy will bring down inflation at a faster rate than is currently predicted.

Despite the fact the economic outlook looks gloomy across the European Union, the low valuations of European small and mid-cap stocks have caught the eye of many an investor, as their relatively low valuation has ignited long-term interest. Whilst recent banking upheaval promoted thoughts of a credit crunch, and recent anxieties regarding an economic slowdown favoured “defensives over cyclicals” *, the smaller European companies have seen valuations sink.

*Defensive stocks are those companies that are recognised to have defensive earnings, that do not really equate to the economic cycle. Such companies usually supply necessities that consumers will not cut back in times of a downturn in the economy. These necessities are typically power, such as electricity and gas, healthcare and certain foodstuffs. 

 *Cyclical stocks are those companies that are recognised as being more exposed to the economic cycle. Thus, when economic conditions are on a downward cycle, these companies are likely to see a drop off in earnings, but if economic conditions are on an upward cycle, then conversely earnings will increase. Such companies are recognised as being in the travel, construction and luxury goods sector.

Many European focused investors suggest that while the current economic slowdown persists, the current price of SMIDs (Small-Mid Capitalisation), have already had much of the risk factored into their price. The thinking therefore is that should Europe enter into a prolonged recession, SMIDs will have less downside than the larger companies or stocks.

In the AI (Artificial Intelligence) sector, breakthroughs in generative AI (algorithms that can be used to create new content such as images, text, simulations, video and audio), have in recent months kept investors focused on mega-stocks. However, from an AI angle those SMIDs that have available resources to invest in AI will hold an advantage over those who lack the same resources.

Expert analysts suspect that European economic data will get worse over the next three months especially as data recently released shows the EuroZone suffering from a technical recession, where there has been negative growth in real GDP in two consecutive quarters. When the data shows an economic upswing across the EuroZone, the revival of small caps will begin, and the same analysts suggest that this will provide a rich hunting ground for those long-term focused investors.

On Thursday 22nd June 2023, defying market predictions, the Bank of England put up interest rates by a full half percentage point, to 5%, the highest level since 2008. Both the Prime Minister Rishi Sunak and the Chancellor of the Exchequer Jeremy Hunt backed the Bank of England to the hilt, confirming Andrew Bailey’s (Governor of the BOE) uncompromising attack on inflation. 

Apparently recent data showed that there were stronger inflationary pressures on the UK economy, thus the Bank of England’s Monetary Policy Committee (MPC) voted seven to two to increase interest rates by 0.5%. The Bank of England is committed to their policy of reducing interest rates to 2% by raising interest rates 13 times since December 2021.

The Bank of England’s expectation that inflation would fall in May failed to materialise with inflation staying at 8.7% well beyond and above the intended target of 2%. Many experts and analysts are suggesting that the rate rises are doing more harm than good and figures confirm that inflation in the UK is the highest of any G7 country.

Such interest rate increases have pushed lenders to reprice their “Fixed Rate” mortgage deals pushing up prices whilst at the same time putting increased pressure on homeowners, which may result in a swathe of repossessions. The Chancellor, having already announced there will be no help for homeowners, did a u-turn on Friday and announced an agreement with lenders where homeowners struggling with repayments would be given a 12 month grace period before any repossessions take place. This agreement encompasses mortgage holders extending their current agreement or moving to an interest only plan.

Due to interest rate increases, the circa two million mortgage holders on tracker rates have seen their monthly outgoings rise every six weeks since December 2021. UK data shows that there are six million households tied to fixed rate mortgages with 800,000 due at the end of the year 2023. We can only hope the Government’s and the Bank of England’s monetary policies can finally start to eat away at inflation avoiding a mortgage time bomb at the end of 2024.