Fisher Investments UK

Inflation is an over-inflated market risk

It appears Mark Carney barely escaped writing a letter to Chancellor of the Exchequer Philip Hammond this week: UK inflation remained at 3.0% y/y in October, exactly one percentage point above the BoE’s target. Whilst we imagine Carney and his typewriter are breathing sighs of relief, headlines aren’t: Most observers still believe high inflation is choking the UK economy, putting the expansion (and UK shares) at risk. History and recent data, however, disagree: Britain’s economy and markets have endured higher inflation in the past, and UK consumers are far more resilient than most believe.

As headlines are quick to point out, inflation is at a five-year high. That sentence cuts both ways. Yes, inflation is higher than at any point in the last five years. However, this also means inflation was higher five years ago. Follow the breadcrumbs, and you see inflation was higher for most of 2010 – 2012. As Exhibit 1 shows, the annual inflation rate first crossed above 3% in January 2010, when it jumped from December 2009’s 2.9% to 3.5%. A year later it hit 4%, and it eventually peaked at 5.2% in September 2011. It didn’t cross back below 3% until May 2012, after the 2011 VAT hike fell out of the calculation.

The UK’s expansion wasn’t the world’s fastest in 2010 – 2012, but it did persist. As Exhibit 1 shows, growth rates were choppy, but GDP contracted only twice: Q2 and Q4 2012. On each occasion, consumer spending wasn’t the culprit. (Exhibit 2) Rather, government spending and fixed investment detracted in Q2 2012, whilst trade detracted in Q4. Consumer spending did fall in Q2 2014, but it seems fair to say January 2011’s VAT hike played a role in that one-off drop.

Exhibit 1: Higher Inflation Didn’t Sink UK GDP

Exhibit_1.png

Source: FactSet, as of 14/11/2017.

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