If you’ve been following our work you’d know that we’ve had a bearish bias on the UK for the balance of the year. The Producer Price Index numbers for September released today by the Office for National Statistics support our thesis that inflation will outpace growth in the UK, adding to the cocktail of negative headwinds for the island nation.
Annual output price (factory gate) for all manufactured products rose 0.4% in September or +0.5% month-over-month, while annual input prices fell 6.5% compared with a decline of 7.7% in August on a year-over-year basis. In short, producers are still benefiting from lower energy (input) costs on annual compares, but sequentially energy, transport, and food costs are inflating --gaining 2.0%, 0.6%, and 0.3% respectively for the month.
Core PPI, or Manufactured Products other than food, beverages, petroleum and tobacco, rose 1.4% year-over-year driven by a 4.4% rise in motor vehicles and other transport equipment and 3.8% rise in machinery and equipment.
With CPI at 1.6% in August Y/Y --and even with initial forecasts for a decline in inflation to 1.3% when September’s reading is released on October 13th, we’re of the camp that inflation is returning to the UK, an unhappy development for producers and consumers coming out of a recessed economy. Remember that Q2 GDP read positive for Germany and France at +0.3% Q/Q, but much of Europe saw contraction, including in the UK at -0.6% Q/Q. From an inflationary standpoint, we continue to like Germany (EWG) at -0.2% to -0.3% (also the Eurozone average), a level we believe will not profoundly impact consumer demand as long as it remains offset by growth.
Returning to the UK, with both the BOE and ECB sitting on their hands during their latest policy sessions this week and keeping interest rates unchanged at 0.5% and 1.0% respectively, we view the BOE in a tenuous and unfavorable position for the intermediate term. On one hand, the Pound has significantly depreciated against the USD and EUR, down 4.7% versus the USD and 7.9% versus the Euro since Aug. 1; clearly the Pound’s fall has eroded purchasing power for a country heavily dependent on imports. On the other hand, while raising interest rates may clearly be needed to dampen inflation, it could also stymie growth.
As we see the tidal shift of Central Banks moving towards raising rates in a post deflationary environment, we’ll have a close eye on BOE and ECB monetary rhetoric and action. Due to the structural nature of the UK economy, we continue to expect underperformance from the FTSE versus its European peers and the S&P500.