September UK CPI inflation takes a breath

Sarah Giarrusso, Investment Strategist at Tilney Smith & Williamson, the wealth management and professional services group, comments on the latest UK Inflation data:

“UK headline inflation CPI printed 3.1% year-on-year in September, relative to consensus of 3.2%, and just slightly below the previous August print. On a month-on-month basis, CPI rose 0.3% (0.4% expected, 0.7% prior). Excluding the volatile food and energy components, core CPI rose 2.9% year-on-year, compared to expectations of 3.0% and August reading of 3.1%. Meanwhile, Retail Price Index (RPI) headline read came in at 4.9% year-on-year, 0.2% above expectations and increase from the previous month’s reading of 4.8%. RPI excluding mortgage payments came in at 5.0%, a rise from the previous month’s figure of 4.9%.

“Unsurprisingly this month saw a continuation of pandemic idiosyncratic sectors driving inflation higher as base effects play out. Restaurants and hotels saw a 5% year-on-year price increase, a slight cooling from the previous 29 year high of 8.5%. Transportation prices increased by 8.3% as supply chain disruptions linger causing a global chip shortage and in turn driving up vehicle prices. Energy CPI rose 2.8% year-on-year, however, this month’s reading doesn’t capture the full extent of the recent large increases (e.g. natural gas) and this will continue to be a driver of inflation next month.

“Soaring energy prices including fuel and natural gas have become a key concern to investors and economists alike. In the UK, the jump in wholesale prices has already forced several energy suppliers out of business, and consumers will be facing higher bills for heating their homes over the coming winter. However, UK consumers are better placed now than in the past. Energy expenditure only accounts for about 2.5% of overall expenditure, almost half the exposure the consumer had in the 1980s. Households have been accumulating additional savings which will help to sustain consumption. At the height of the pandemic the household savings rate was at 22.5% compared to a long term average of 9%. This has been falling over the last 18 months, however, remains at 11.3%.

“A key risk to markets from higher inflation is the policy response from the Bank of England. Governor Andrew Bailey looks perhaps the most hawkish of the four major central bank leaders, given the BoE is the least tolerant to an inflation target overshoot. As the CPI figure continues to print above the 2% target, it’s becoming more likely that interest rates will be lifted from the effective lower bound earlier than expected. Money markets are now pricing in a 25bp rate hike in December 2021, compared to a month ago when a rate hike wasn’t expected until June 2022. However, since rising inflation is an accumulation of multiple factors including external supply shortages and not just an overheating economy, it seems unlikely for the Bank to undergo an aggressive tightening cycle which could dampen economic growth.

“We therefore advocate keeping a shorter duration in our fixed income portfolios and continue to view the overall outlook as conducive to better performance from equities than bonds.”