Blain’s Morning Porridge Special – December 21st 2023: The reality of consumption vs market hopes: inflation, rates and wages.
“Hallelujah, Noel, be it heaven or hell, the Christmas we get we deserve.”
Markets are poised for the strongest year finish in decades, anticipating early rate cuts and upside in 2024. Meanwhile consumers wrestle with wages falling behind costs, while businesses struggle with debt. The gap between expectations and reality is simply too wide – and will become increasingly apparent.
I think I will have to stop watching the TV news next year. It only upsets me. Yesterday the reporting of the UK’s 3.9% headline Consumer Price Inflation rate was hailed it as a fall, a near-miracle. But the fact the rate of Inflation has decreased does not mean prices have fallen. Nope. Its means prices are rising less fast than they were last month. The speed at which prices are rising is slowing.
That it still costs more to buy many things this month than it did in November is something I fear neither the awfully nice people in the BBC or the less nice people in government have a handle on. The Tories are smugly luxuriating in the extraordinary possibility they actually delivered one of their 5 stated goals: bringing down inflation. They got lucky – inflation around the globe has fallen much faster than even the optimists predicted. (The global economy proved far more resilient to the energy shock than expected, and the inflation spike threatened by bailout support and Covid savings being spent was quickly hidden in the energy price numbers.)
The decline in the pace of inflation has markets in fits of ecstasy! US Bonds are on course fo best year ever. Traders are betting UK numbers will pressure The Bank of England into early easing – interest rate cuts sooner rather than later. They make a simple calculation based on as many positive variables they can think of: lower interest rate are good for companies, makes stocks look more attractive, reduces default risk and means mortgages will fall meaning consumers will have more disposable income to splash around.
The government thinks much the same way. A lower inflation rates means “job done” and maybe they can still win an election. For the Tories to win, the actuality is Labour will have to lose it – historically a good each way bet here in the UK. I’m wondering if the BBC know it is cheerleading govt propaganda with its joyous positivity on slower price rises? They do seem to be missing the point.
The market’s Pavlovian uptick response to slower inflation is a triumph of expectations and hopes over reality. Traders and investors confidently predict a boom time around the corner based on what their rosy future vision looks like. It depends on the market believing rates cuts are coming.. not on the actually reality of when, how much and if.
Back in the real world, there are two pointers of worse to come:
- Lloyds Bank’s barometer of UK business confidence just suffered its biggest decline in 15 months. Small businesses are struggling.
- The UK is about to suffer an austerity Christmas on the High Street. Stores are already massively discounting. Christmas family talk is around “let’s not do big presents this year”.
Businesses are not about to start investment in plant or services, have put expansion plans on hold and are pausing hiring. They are waiting for lower rates to bail them out and refinance. The looming debt crisis at the Issa Brothers ASDA/Forecourt empire will be…. “educational”.
Consumers are not about to start spending because the pace of inflation has apparently fallen. What they are experiencing is increasingly stretched monthly wage/salary earnings because as prices are still rising, rents are rising and costs are rising – but their salaries are static. They look around at the prospect of higher energy and water bills. They perceive the brutal reality their wages are tumbling behind.
Result: slash spending and higher debt to stay afloat, even as debt prices rise making their position even less tenable. Consumers are calculating their spending based on their last sub-inflation pay rise. You can only afford so-many Christmases on BNPL.
When consumption falls… no matter how much the market expects The Bank to ease rates, the economy will contract. I’m certain UK have peaked, but I have little expectation they are set to fall quickly or substantially.
When The Bank does cut interest rates are not likely to fall much. Even if inflation falls back to the 2% target, rates are not going back into negative real rate territory – less than inflation. At best UK rates may eventually fall to 3-3.5% with positive real normalised rates. As a result investment and consumption will remain lower than the market expects because firms and people will have less money and can’t afford to pay more for it. Fact.
For Central Banks it’s not just about inflation. It’s about the right price of money/interest rates. Ultra low rates create more problems than they solve – including making government bond markets less sustainable when rates inevitably rise. Central Banks know they have to normalise interest rates to encourage long-term business investment, deleverage and keep bond markets open.
In terms of inflation, The Bank is not daft. It will not be spooked into pre-emptive moves. Prices have not fallen, and inflation remains a threat. (And if inflation isn’t the threat, and the economy is so weak, then deflation is also a threat. One seldom mistakes a Scotsman, especially Bill Blain, for a ray of sunshine.) They know the risks of higher prices remain very pertinent.
Don’t think of inflation as just a number. It’s based on real economic events. What are the causes of inflation?
- Food prices have stabilised. But… the UK is one of the largest importers of food. If sterling falls (as it did yesterday) then the costs of imported food will likely rise. With an El-Nino climate event underway the prospects for global food production could deteriorate further pushing up prices. In the UK, the miserable weather could see home produced food costs rise dramatically next years. Carrots – hailed as a wonder food during the second world war because they grow easily in the UK – went up 26% this year, mainly because there was no-one willing to earn pennies picking them!
- Services – costs for everything are increasing because; stuff doesn’t work, so many jobs can’t be filled, and productivity has fallen off a cliff because those in work, don’t!
- Energy prices have also fallen – but are volatile to the weather and geopolitics. Due to the structure of the UK energy market, increases in bills feed in slowly, meaning even if market prices fall, the cost to industrial and retail consumers will continue to rise – further impacting discretionary spending.
- Global supply chain costs will receive another shock from the Red Sea choke point. The costs to ship containers from Shanghai to Rotterdam and New York rose this week – but stayed flat to LA – which doesn’t need the Suez Canal!
- Brexit – not a problem say the usual suspects – is a problem. Friction, barriers, and paperwork (apparently we will suffer three passport checks from August next year to get off this Island), push up costs, and restrict the flow of the workers we need to pick carrots – thus further inflation is coming.
- Wage demands are not falling. Striking junior doctors are just one example of professional workers who look around, feel overworked, underpaid, and underappreciated. But pay them more and everyone else will demand more.
The junior doctors are a revolting bunch. How dare they complain about their hours, their debt, how bad conditions are in hospitals, burn-out or wanting to go off and do something else… Some of them earn up to £15 per hour! They have no right to complain about poor Mrs Michelle Mone, whose family are suffering terribly from making a £60mm profit selling £112mm of useless, not-fit-for-purpose bin-bags gowns to the NHS under the Tory VIP pathway. (US Readers – furious sarcasm alert.)
Meanwhile, something to worry about next year.
One of my big fears for 2024 is the potential collapse of NATO – It would be an invitation to Russia and China to go even more outward bound. NATO could be compromised if Trump is elected. To avoid giving Trump the ammunition to pullout, Europe needs to show it is meeting Defence Spending commitments.
Yet, the most recent report into the UK armed forces’ equipment spending by the National Audit Office highlighted just how deep the equipment spending crisis in the Ministry of Defence (MOD) has become – it is described as “unaffordable”. Read the conclusions here. There is a potential £30 bln planned spending shortfall. One of the main drivers of cost overrun is inflation – although military procurement has always been.. “interesting.” Cuts are inevitable, leaving the already poorly equipped and undermanned services struggling to meet basic commitments.
This morning, in the Thunderer, read: “Tony Radakin and Defence Cheifs “gagged by paranoid Rishi Sunak.” Its pretty shocking and deeply worrying. The primary duty of a nation is to defend its people. The current minister at the MoD is the “spreadsheet assassin” Grant Shapps.. allegedly one of his first comments on taking the role a few weeks ago was praising the RAF’S Aircraft Carriers – which probably peeved the Navy somewhat.
Five Things to Read This Morning
Times Partygoers warned of risk to sight from 50mph champagne corks
Guardian May General Election? The economic case for going early (and clinging on)
FT Narendra Modi: “Our nation is on the cusp of a take-off”
BBerg Crypto Gets Crazy Again With Dog-Inspired Tokens and BitCon Eying $45,000
WSJ Trump vs. the Banana Republic of Colorado
Out of time, and off to look for a day-job
Bill Blain
Author of the Morning Porridge, Strategist
