Today’s CPI number for the UK came in at an unexpected increase of 5.25% over the same month last year –a decade high. Despite the commodity sell off British consumers are still feeling the pain of the Pound’s decline in their wallets.
This increase in CPI has left the Bank of England caught in a in a tug of war between near term inflationary concerns and the capital markets liquidity draught. Last week’s 50 basis point rate cut has not yet created the desired market stability; meanwhile the UK public pension system is pegged to the inflation index, meaning that the government faces billions in additional state payments if inflation rises. In theory the potential exists for a vicious cycle -rising inflation levels contribute to increasing public liabilities, potentially further weakening the Pound against the Euro, Dollar and Yen and contributing to more inflation. This worst case scenario seems unlikely. In fact, most economists are counting on decreasing food and fuel costs to get inflation levels back below the government’s target rate of 2% rapidly, but the prospect of any further weakness for the Pound is still sobering.
Even if inflation does recede quickly, national debt is still on the rise. The first bank bailout linked bond issuance, 30 Billion Gilts and 7 Billion in Treasury bills, has been announced with an additional 70 billion+ expected to come to market over the next several quarters.
We sold EWU into this morning’s knee jerk rally in response the US bank bailout announcements. This is a significantly damaged economy that will take time and pain to right itself, making the decision to sell into near-term wishful thinking a lot easier.