Sorry to continue to harp on this but Mark Carney and the BoE have a problem on their hands. I’ll call it the Arthur Burns/G. William Miller problem, the two Fed Chairman in the 1970’s who focused more on employment than the flaring inflation, //www.federalreservehistory.org/Media/Image/EventDetailMain/38-1. Rule #1, a steady currency and thus stable prices is the precursor to a healthy economy, higher real wages and a strong labor market. Instead, the BoE is headed for a stagflationary type situation after February CPI jumped .7% m/o/m and 2.3% y/o/y and this was more than just energy as core CPI was higher by 2% y/o/y. The estimate for headline was 2.1% and 1.7% for the core rate. The core rate has a 2 handle for the first time since June 2014. The only respite in the data, but wasn’t much of one, was the 19.1% y/o/y increase in input prices instead of the 20.1% that was expected. Say goodbye to any profit margin as wholesale output prices was up just 2.4% y/o/y.
Mark Carney is stuck between his price stability mandate and the large unknown of how the Brexit negotiations will go, how long it will take and what economic impact it will have in the meantime. I’m of course being dramatic with the Carney/Burns/Miller comparison because of the double digit inflation rates back in the 1970’s but I think you get my point.
The market response was immediate and dramatic as the 2 yr Gilt yield jumped by 5.5 bps to .14%, not much still but double the level of one week ago. The 10 yr yield is higher by 4.5 bps to a 4 week high. The 5 yr inflation breakeven rate is spiking by 8 bps to 3.10% vs 2.3% on the day of the UK referendum vote (see chart):
The pound is up a full dollar to just below $1.25. The FTSE 100 is down modestly on the pound strength. The FTSE 250, much less impacted by the pound as companies are more domestically focused, is also lower by a slight .2%. The strength in the pound is dragging the euro to $1.08 and this would be the highest close vs the US dollar since November. I remain bullish on it because the ECB is backing off from QE and the French debate results last night also helped as Emmanuel Macron performed well according to two post debate polls. The euro heavy dollar index has broken below 100.
I reiterate my bearishness on UK bonds (and other sovereign bonds) and bullishness on the pound as the BoE will hike rates and end QE this year I believe. I’ll also repeat again that 2017 will mark the first year in this economic recovery that all 4 central banks will in some form be removing accommodation. If you think the P/E multiple for many developed markets expanded by more than 50% over the past 5 years because the fundamentals were great, I’ll vehemently disagree with that.
5 yr UK Inflation Breakeven Rate
The other type of inflation the UK has on its hands is in housing. Home prices rose 6.2% y/o/y in January and has risen by 5%+ for more than 3 years now, well above the consumer rate of inflation. Sorry if you’re looking for a flat in London as prices there were up 7.3% y/o/y.
We hear from 3 more Fed members today but none vote. Dudley spoke this morning but said nothing on the economy and monetary policy. Don’t even get me started on Neel Kashkari and his media and essay blitz trying to explain why he thinks .625% is the right rate for an economy that is approaching its 9th year of this recovery, has seen core CPI 2%+ for 15 straight months, his preferred focus on core PCE is near 2% at 1.7%, inflation expectations in TIPS is at 2% and the unemployment rate is close to 4.5%.