Cameron’s Inflation Conundrum

Conclusion:  As opposed to Germany, we expect to see a significantly higher level of inflation in the UK over the intermediate term TREND. PM David Cameron and his government are in a tough place as stagflation sets in. Today we bought Germany via the etf EWG in the Hedgeye Virtual Portfolio as the DAX tested and held both its TRADE and TREND lines of support.

This morning in the Early Look Keith noted some very important demand drivers of long-term secular inflation, namely:

  1. CRB Commodities Index hit a new YTD high yesterday for 2010 (up +13% since August!).
  2. Copper prices are up +28% since August and are now testing their all-time peak prices of 2008.
  3. Chinese stocks have rallied +20% since their July lows.

To further contextualize the inflation/deflation debate, below we show a chart of UK and Greek inflation, two countries that are experiencing inflation above their European peers. Importantly, you’ll note the spread over German inflation, with CPI at +1.3%.  And the UK’s Retail Price Index, the very goods and service that households consume, is up +4.6% year-over-year or +0.4% month-over-month in September.

Cameron’s Inflation Conundrum - uk1

As we noted in a post on 10/8 titled “UK and Inflation’s Ugly Head”, PM David Cameron and his government are now at a crossroads as austerity measures in the UK (and throughout Europe) squeeze the consumer via higher VAT and growth slows into year-end and in 2011. Now Cameron and Co. must address the broader economy from a fiscal and/or monetary perspective in the next months:

  1. Go the likely route of the US (and potentially the Eurozone) in issuing some form of QE2, ie printing money which should further inflate prices and depreciate the Pound, and/or
  2. Raise the benchmark interest rate to quell inflation, but risk further choking off growth

While we are not going to speculate on the action of the divided Bank of England, we expect to see significantly higher inflation in the UK over the intermediate term TREND. Like in the US, an environment of declining growth and expanding inflation (stagflation) should fuel the unemployment picture.

We’re steering clear of the UK economy on the long side. We bought back our position in Germany (EWG) today on a pullback as it held its TRADE line of support at 6,230 and TREND support of 6,112. We’re currently short Italy (EWI) in the Hedgeye Virtual Portfolio

Matthew Hedrick

Analyst

Cameron’s Inflation Conundrum - uk2