The UK’s December CPI figure of 5.4 per cent for the year was higher than expected and reminded Paul Craig, portfolio manager at Quilter Investors of the situation 30 years ago.
“It’s back to the 90s for inflation,” Craig writes, “with CPI hitting 5.4 per cent in the year to December, the highest level since March 1992. When inflation was last this high, John Major was Prime Minister and Silence of the Lambs had just picked up an Oscar for Best Picture at the 64th Academy Awards.
“It’s not so much Silence of the Lambs now but Silence of the Doves. The Bank of England is vindicated in its decision to hike rates in December in the face of Omicron uncertainty, but it could still go either way when the MPC meets in early February.”
Craig notes that the MPC will be faced with a difficult trade-off between ensuring financial stability or helping households cope with a cost of living crisis that is set to squeeze household finances over a difficult winter period.
“It’s not just the cost of living that is increasing, so is the cost of going to work, and wage increases may not be enough to cover the cost of returning to normality. The ONS published figures showing wage growth of 3.8 per cent yesterday, so workers are facing a real terms pay decline of 1.6 per cent. Taken together, there is a very real concern that in-work poverty is growing,” Craig writes.
“It seems like madness now that only a year ago we were pondering whether the Bank of England would take rates below zero, but even with inflation hitting 5.4 per cent, things will get worse before they get better. Inflation is expected to peak in the second quarter before starting to settle down in the latter stages of 2022 and early 2023.
“We are at a historical juncture for markets and developed economies, which are battling with inflation numbers not seen for decades outside emerging markets. Investors are faced with a delicate market environment, at the moment, and they will need to watch the data and markets very closely and allocate accordingly. Diversification, active management and prudency are the key tools for investors to use now.”
Meanwhile, over at Tilney Smith & Williamson, Sarah Giarrusso says: “The rise in annual headline inflation was mainly driven by higher food and energy prices. Food and non-alcoholic beverages rose by 4.1 per cent over the year and electricity, gas and other fuels rose by 22.7 per cent. The rate of annual core inflation increased slightly and remains at high levels. The biggest drivers continue to be transportation which includes new and used vehicle prices caused by supply chain disruptions which has shown little signs of abating. Restaurant and hotel prices remain elevated with accommodation services reaching new highs, rising at an annual rate of 15.5 per cent.”
Giarrusso comments that given inflation has reached a 30-year high, the Bank of England (BoE) is under pressure to stabilise prices.
“At the last Monetary Policy Committee meeting in December the BoE decided to raise interest rates from 0.1 per cent to 0.25 per cent despite the uncertainty around the spread of the Omicron variant of COVID. The Bank is likely to raise rates further throughout the year to help bring inflation back down to the 2 per cent target. The economy is in a relatively strong position to weather raising rates as the labour market continues to strengthen. The employment data compiled from HMRC released yesterday showed that in December 184k jobs were created, which is 410k above the pre-pandemic level.
“A shortage of workers brought on by the pandemic has caused wage growth to increase. However, after hitting a peak of 8.8 per cent in the three months to June 2021 these wage pressures have eased somewhat. The most recent data showed a slowing in the annual average weekly earnings growth from 4.9 per cent to 4.2 per cent. However, wage rates still remain at elevated levels.”
However, Giarrusso believes that despite rising input costs including raw materials and wages, company profit margins remain relatively healthy for the UK equity market.
“The strength of the UK economy is expected to continue with analysts forecasting an annual growth rate of 4.6 per cent for 2022 and 2.5 per cent for 2023 and inflation is expected to fall from highs of 5.6 per cent in Q2 2022 back down to the central bank target of 2 per cent in Q1 2023. This is likely to continue to support company’s earnings and boost optimism for UK equities.”
Over at AJ Bell, Laith Khalaf, head of investment analysis, comments that inflation is going to pile serious pressure on UK households in the next few months, particularly when combined with the tax rises the Chancellor has planned for April.
“The main issue is that price rises are being most keenly felt in energy and transport, areas where expenditure is unavoidable, and which constitutes a bigger slice of the budgets of those on lower incomes.
“CPI now stands at 5.4 per cent, the highest annual reading since this measure of inflation was introduced in 1997, though significantly higher price rises were recorded in the 1970s, 80s and early 90s, when the now largely retired RPI measure was used. It will be little comfort to those feeling the pinch of price rises today, but looking over a slightly longer period, CPI inflation has risen by 6 per cent over the last two years. That’s only slightly more than it has increased over one year, thanks to the deflationary effects of the pandemic in 2020, which saw some oil contracts trading in negative territory, and tells us just how sharply prices increased over the course of 2021.
“The annualised nature of the inflation calculation suggests this spike may recede if commodity prices fall back towards the end of this year, or indeed simply fail to keep rising. Whether that will happen will continue to depend on Russia, OPEC and supply chain disruption. But commodity prices are cyclical, and as the saying goes, the cure for high oil prices is high oil prices.
“Probably a greater threat in creating sustained inflation comes from the labour market. A record level of vacancies, combined with a hefty increase in the National Minimum Wage could give a wage price spiral a bit of momentum, taking root first within companies, and then manifesting itself in consumer prices. It was telling that the high street retailer Next has just warned the market that it faces 5.4 per cent wage inflation this year, and when added to elevated shipping costs, that means item prices are expected to rise by 6 per cent. If this sort of thing is happening across the economy, the risk is that inflation becomes embedded in the expectations of business and consumers, at which point it becomes much more sticky.
“The Bank of England has of course raised base rate back to 0.25 per cent, but that still means that cash savers saw their money lose 5 per cent of its buying power in 2021. The coming year isn’t shaping up to be much better, because the pace at which interest rates rise will only negligibly take the edge off inflation. The market is now expecting in another rate hike in February, but as we’ve often seen, the Bank doesn’t always follow the script laid down by market prices.”