UK Economic Update – 14 November 2014
Bank of England signals lower for longer; FTSE 100 breaks back above 6,600
The FTSE 100 closed the week higher once again this Friday despite another wave of fines hitting the financial sector and a further escalation of the supermarket price war in the UK.
Gains for the index were supported by a stable reading of the Chinese consumer price index on Monday and anticipation of a dovish update from the Bank of England governor Mark Carney on Wednesday.
While Chinese data eventually faltered toward the close of the week, Mark Carney didn’t disappoint when he conceded to the quarterly inflation report audience that policy maker expectations for CPI during the months ahead have fallen of late.
The governor also acknowledged that there is a possibility inflation could dip below 1% for a period of time during the coming quarters, therefore requiring an open letter to be written to the Chancellor explaining what the bank is doing to prevent it price pressures from receding further.
Although the governor cited imported disinflation and continued weakness in the euro-zone (largest export market) as a key driver of the disinflationary trend in the UK, we caution that there are other equally poignant forces at play; many of which are unlikely to fade with any uptick in EU economic health.
Most notably, food prices in the UK have been in free-fall throughout much of the last 12 months, with the July under-performance of UK retail sales numbers being largely attributable to the first fall in the £ value of food store sales since records of such expenditure began in 1989.
Behind this trend is the changing dynamics of the UK grocery market, made plain for all to see in the current turmoil of Tesco and the price war which is playing out across the wider industry.
In addition to the above, energy costs are stagnant if not falling across the board. With uncertainty remaining over the likely direction of government policy after the general election in 2015, and much to the relief of many consumers; few energy companies have been willing to seek any form of significant increase to unit energy costs.
Furthermore, oil prices have fallen to a four and a half year low in Europe during the last six weeks and little evidence exists to suggest that prices may recover over the near term.
In fact, consensus expectations among analysts and investors indicate that lower levels could still be in the pipeline for crude benchmarks. This is as the oil market currently faces a glut of supply in the face of diminishing North American demand, after advances in shale oil extraction techniques drove US production in 2014 to its highest level since the OPEC oil crisis of the 1970’s.
While it is possible that the market will correct naturally as either OPEC curtails output to boost prices, or smaller shale producers eventually cease drilling in the wake of oil price weakness; neither of these will present a durable solution to the dilemma facing oil producers at present.
As a result, we do not see a marked shift in inflation expectations as likely for the UK over the near term.
With the above taken into account, the implications of the inflation outlook for the UK can be summed up in a few short words; – lower for longer.
With deflation more of a concern than inflation across the developed world, and factoring the ongoing contraction in real wages; there appears little merit in any argument for an upward move in UK interest rates in the near future.
This of course is positive for equities as rates remaining at their current lows for a longer period of time still amounts to ultra loose policy, which in light of the monetary policy environments across developed markets such as the EU and the US; leaves little alternative destination for investors seeking yield.
FTSE 100 // 10 Minute Intervals
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