Positions in Europe: Short EUR-USD (FXE)
The UK recovery is off-track, said Bank of England’s Mervyn King today. You think…?
Our thesis remains intact: the UK economy is experiencing stagflation that should persist for at least the next 2-4 quarters in an optimistic scenario. Real growth should remain impaired from domestic austerity that weighs on confidence, spending, and tax receipts, as sovereign debt and banking contagion fears across continental Europe expand and reduce appetite for UK goods and services. (Note: European nations are collectively the UK’s largest export partners).
Further, while members of the Bank’s Monetary Policy Committee voted 9-0 to increase its gilts purchasing program by £75B over the next four months [the BoE bought £200 Billion in asset purchases (QE) between March 2009 and January 2010] and keep its main interest rate at 0.50% in an attempt to will growth, we think the actions may do little to move the needle.
The BoE minutes from the October 5-6 gathering show that consensus believes Q4 growth will be close to zero. We see the UK dipping back into recession, as inflation continues to surprise the BoE to the upside for a protracted period. Yesterday’s release of September CPI at +5.2% year-over-year, versus 4.5% in August, on a tough +3.1% comp in September 2010, demonstrates the sticky stagflation hampering the economy. Equally, Input Producer Prices continue to drive Output Prices higher, another negative for spending (see charts below).
The components that saw the largest year-over-year moves were gasoline, up +22.3% and alcoholic beverages and tobacco, up 10.0%. Based on September monthly averages of Brent crude on a year-over-year compare, Brent saw a +28.5% gain, a pressure the country can do little to reduce given its dependence on foreign sources. NOV., DEC., JAN., and FEB. Brent comps should could well prove inflationary. Alcohol and tobacco gains came at the hands of higher taxed for these goods.
The broader UK fundamentals we follow also portend a negative set-up: PMI (Services and Manufacturing) have yet to confirm a positive uptrend, down around the 50 line for the last months that divides expansion (above) and contraction (below); the Unemployment Rate ticked up 20bps month-over-month to 8.1% in August; Retail Sales remain anemic, at 0.0% in August Y/Y; and housing has yet to show any meaningful improvement.
The downward revisions to Final Q2 GDP, bringing year-over-year growth down 10bps to 0.6% Y/Y and quarter-over-quarter growth down 10bps to 0.1% Q/Q have also contributed to the less-than-rosy outlook (see chart below).
We do not have an active position in the UK in the Hedgeye Virtual Portfolio, but have used the eft EWU as an investment vehicle in the past.