The BOE Sees Inflation?

Hedgeye Positions in Europe: Long Germany (EWG); Short Italy (EWI), Euro (FXE)

The answer to the question, Does the Bank of England see inflation?, appears to be a qualified ‘yes’.  Today the Bank of England published the minutes from its December 8-9 meeting and one sentence stood out:

“Most of the members considered that the accumulation of news over recent months had probably shifted the balance of risks to inflation in the medium term upwards.”

We’ve highlighted inflation risk in the UK over the last months as the Bank has reported CPI above or at its target of 3% for most of the year. With CPI currently at 3.3% in November year-over-year, we’re likely to see further upside pressure on CPI in the coming quarters due to an increase in VAT to 20% (versus the current rate of 17.5%) in January 2011, a weaker Sterling versus major currencies in the 1H 2010 on the comp (see chart), and inflationary global commodities that we’re calling for next year.

The BOE Sees Inflation? - currency chart

The Bank, despite two dissenting members, maintained that the Bank Rate should remain unchanged at 0.5% and its asset purchase plan unchanged at £200 Billion. Again, we see the Bank largely handcuffed on monetary policy: the Bank can neither raise rates to quell inflation for fear of further chocking off the economy nor buy more paper (to potentially spur growth) for fear of stoking further inflation.

A sticking point remains the country’s fiscal policies, namely its austerity measures, that should threaten growth through increased taxes, job cuts, and dampen business and consumer confidence. Today, the final reading of Q3 GDP in the UK showed downward revisions. Year-over-year Q3 GDP was revised to +2.7% (versus +2.8%) and quarter-over-quarter GDP was revised down 10bps to +0.7%. 

We don’t have an investment position in the UK, but clearly we’re worried about inflationary pressures over the coming quarters given the country’s weak growth prospects next year.

Matthew Hedrick

Analyst