Blain’s Morning Porridge – May 25^th 2023: UK Inflation is Sticky… Wow! Try telling that to the Bank of England. Why?

“There are rules in economics stating some models work and some are useful. Except within the Bank of England where neither applies.”

Yesterday’s UK inflation numbers hint the Bank doesn’t understand the modern drivers of inflation or how to address them. It leaves some stark likely outcomes: stagflation or a Reflationary Death Scramble. Neither are good.

First up this morning: A gentle reminder to all readers that a fall in the headline inflation rate does not mean prices are falling. It means they are rising – just a little less quickly.

The great thing about truly miserable UK inflation data yesterday is it gives me something to be really peeved about this morning. It’s so much more interesting than curing insomnia by writing about US debt ceiling procrastination…….. zzzzzzz.. sorry… nodded off there. Or maybe the woes of bank bonds and US regional banks, or the sheer tedium of whatever else is happening. I mean, seriously, have you ever tried to write anything readable about the Japanese economy without flatlining? (I have a doctor’s note to say I am excused Japan…)

“Inflation is always and everywhere a monetary phenomenon” – Milton Freidman’s diktat at the core of monetarism – is true to a very, very limited extent. For the 13 years of post Global Financial Crisis monetary distortion, (ultra-low interest rates and QE), plus deflation from cheaper and abundant goods from Asia, Central Banks got away with pumping up the volume of money. It had zero discernible effect on inflation, hidden behind the stage-curtain of financial asset inflation (which is why stocks remain so fundamentally overvalued) and falling costs. Hard Line militant Monetarists still believe it as an article of faith, although it took a war and an energy cost spike to crystalise inflationary fears – which are expectations driven.

In money supply, as in so many things, Monetarists are largely wrong. As wrong as the Bank of England has been about inflation. Blaming the Bank is a bit like baby seal clubbing… they are so cute and loveable, but Canadian fisherman to want to bash the bejesus out of them for eating all the fish. Around the City trading desks, folk at looking at the Bank in disbelief for being so utterly and completely wrong in their inflation forecasts.

So much for transitory. Yesterday’s UK Inflation number shows inflation is sticky. No Sh*t Sherlock. Where does the economy go from here then…? Stagflation or a Reflationary boom? Pick yer poison Mr Bailey.

The UK numbers were actually much, much worse than you think:

• UK Consumer Price Inflation slowed from 10.1% in April to 8.7% in April – but ex-tumbling energy and commodity prices inflation is it is still way above official forecasts, and still running hot. If not for falling fuel prices, the UK would be recording yet another quickening in the pace of inflation. There is a time element to inflation: the brutal reality is inflation is becoming more deeply established rather than moderating. Why?
• UK food price inflation remains at 19% – meaning bread will cost more tomorrow and salaries will stretch that little bit less far…. “and whose share is this” as we divi up the last few baked beans. Why?

The Bank tells us inflation will fall. Yes. It will – that’s inevitable. Ultimately, it’s a Zero-hedge.

But in real-time, inflation is not a simple monetary calculation about velocity and supply of money – it’s about the behaviour of the entire, not-terribly rational, economy. It is the cumulative  decisions of individuals acting alone or collectively, of companies and of governments that combine and interreact to drive inflationary expectations, which act as a constantly evolving feedback loop or inflation driver in the economy.

And that feedback process is speeding up as information, views, opinions and information is shared ever faster on the news, social media and through markets. Within moments of yesterday’s UK numbers Gilts and Sterling were crashing, and the media was all over it like a cheap suit. Bond yields are absolutely the most important numbers in finance, but when I started in markets 40 years ago, bonds only appeared in a brief comment of page 5 of the second section. This morning Gilt yields are the front page headline.

Gilts are back where they were during the Truster*uck last year (discredited premier Liz Truss’s attempt to destroy the UK’s gilts market, crush sterling and unravel politics by demonstrating the numpties were in charge.)  They will rise further – with further real consequences on returns, expectations and economic decision making. Real yields are still negative meaning you lose money on every bond you buy before the pixels have dried on the digital transfer docs.

The Bank is expected to hike at its next meeting in June. Really? Quel Surprise…

If anyone is interested – and no doubt they are – that’s 2-years now the Bank of England’s inflation model has been wrong. Therefore, one of coveted “No Sh*t Sherlock” awards is winging its way to Governor Andrew Bailey for his astute observation there are “very big lessons to learn” about economic models and inflation drivers. I will also be sending him my very own strategic thinking device – a 20 sided dice – to assist him guess next month’s number. Sure, its probably as a good… nay better than economists. (I used it playing Dungeons and Dragons decades ago, but I reckon it will work just as well in whatever imaginary economic space/time dis-continuum the Bank is working in.)

Meanwhile, The Bank’s very own plate of dismal mince says he is now wondering if its models and frameworks of inflation data in the 1970s and 80s might need revisiting. You think? A few weeks ago he was telling us to tighten our belts, stop demanding higher wages, and take the medicine as the Bank sorted out inflation. Yesterday, the plate of mince accepted that apparently wage inflation today is very different to the last inflation surge when we had out and out inflation as Maggie Thatcher randomly closed every second factory and decimated the work force with P-45s. Although she could balance her grocery bill, the nation was plunged into deep stagflation.

Apparently Wage Inflation is different this time.. again… You Think? Rhetorical question to which the answer is yes. It is. Now deal with it. Hint: Yesterday the IMF raised its forecast for the UK and expects we will avoid recession. That likely means inflation for longer in a reflationary economy.

The Bank, and I guess Government (although I doubt any of them, except Rishi Sunak, actually understands it… maybe Michael Gove, but he will be working out what duplicitous  angle he can play off it to become premier himself..), have a simple choice. Hoik interest rates aggressively to slash inflation, plunge the nation into a deep recession and hope it doesn’t become Stagflation. Or they can pretend they are trying for a soft-landing and turn the UK into some kind of proxy Weimar Germany by letting inflation run it’s course by simple dint of getting the forecasts wrong everytime…

Either ways the economy breaks:

• Crash landing into Stagflation.
• Or it goes into a Reflationary Death Scramble – yeah, that’s a phrase I’d never heard of it either till I invented it 14 words ago. Wage demands go ballistic. Companies keep increasing prices. Pensioners and savers starve. It’s my new theory that prices and corporate profits continue to soar ever upwards right to the point we get the Willy-e Coyote realisation moment. You know exactly the moment I mean. See picture..

What’s the problem with the UK? Why is inflation declining elsewhere, but not in the UK? Because we now expect it to rise faster. People are more inclined to demand higher wages, unions will fight for them, corporates know wages are rising so hike prices, Government tries to calm expectations but makes them worse.. Death Scramble…

Core inflation remains faster (yes, that’s the right word, faster not higher!) than expected. It’s no longer about energy or commodity, or even global supply chain fractures.. It’s all internal – it’s the UK economy that is imbalanced. Rate hikes have failed to reduce the strains. These include wage costs – no one can afford to live in London anymore, so a barista is now on a salary similar to a 3^rd year Goldman analyst, explaining why last week’s £5.40 flat white was a small family car yesterday.

There are supply chain cost issues – everything costs more because Brexit was such a brilliantly brilliant and great idea. The LSE estimates trade barriers put in place by Brexit contribute 8 points on food inflation – proving just how clever we were. Boris you legend… Companies see rising inflation, rising costs, so raise their prices and then some more. The price of everything creeps up. The size of executive bonuses are therefore equally inflated – and their bonuses increase as they hold worker pay down, ultimately ensuring demand drops and companies go bust.

Where do we go from here? Political instability anyone? Pitchforks or Torches? (The trick, of course, is persuading the guys with the Pitchforks that its all the fault of the folk with the Torches, and vice versa.)

A reader reminded me of the 1923 German wheelbarrow story: a chap was wheeling a wheelbarrow full of cash down to the bakers to buy a loaf. He stopped for a moment to see what a queue of people were in line for; when he turned back someone had nicked the Wheelbarrow, leaving the cash on the street.

I am off racing my boat to France early tomorrow morning. No sure if I’m going to get back as the weather next week looks …. Fresh. The boat is fully computered up… what can possibly go wrong..

Five Things to Read This morning:

FT        The Bank of England needs to improve its communication on inflation

BBerg  The Leveling Down of Britain’s Home Rental Market

WSJ     Inside Wall Street’s Playbook to Prevent Debt-Ceiling Chaos

Guardian         Failure to grasp UK Inflation drivers will continue to keep prices high

Torygraph        Michael Gove orders investigation into corruption at UK’s biggest freeport

Out of time, and back to the day job. Porridge will resume next week.. have a good one…

Bill Blain

Strategist – Shard Capital