The UK Sees Inflation

Position: Long Sweden (EWD); Short Italy (EWI), and Euro (FXE)

As was the case in Ben Bernanke’s testimony before the House Budget Committee today, it continues to amaze our team that The Ber-nank says he sees no threat of inflation domestically and has no concern that US monetary policy is contributing to massive inflation in global commodities. In contrast to Bernanke, both ECB President Trichet and BoE Governor King have expressed in recent weeks that 1.) they see inflationary pressures mounting, and 2.) they’ll appropriately address inflation through monetary policy. 

While we don’t purport to have a crystal ball to predict when central banks will raise main interest rates, the rhetoric from the ECB and BoE would suggest a much higher probability that they’ll raise rates sooner than the FED. In fact, we think the BoE will be the first to raise given the higher rates of inflation that the economy is being hit with.

In the UK, CPI has ticked higher over recent months –currently at 3.7% year-over-year—and data out today from the British Retail Consortium on the UK Shop Price Index showed further confirmation of this inflationary trend with price inflation for the overall index, and food inflation accelerating at the fastest pace in 19 months (see table insert in chart).

The UK Sees Inflation - pen1

We think in the near-term, and as soon as this quarter, it would be prudent for the BoE to hike to combat inflation. However, pinning the tail on the timing of a hike is exceedingly difficult, especially given that there’s significant concern that a hike would stymie the already weak GDP outlook for the country this year and next. No doubt the UK economy is in a tough policy spot. The chart of 2 year UK government bond yields below continues to warn of pressing inflationary risks.

The UK Sees Inflation - pen2

With the minutes of the last BoE meeting on January 13th showing a shift by most members to the upward medium-term inflation risks, we’ll take our cues from the action and any incremental statements from King and Co. tomorrow.

Matthew Hedrick

Analyst