NOVEMBER 17, 2021
Daniel Casali, Chief Investment Strategist at Tilney Smith & Williamson, the wealth management and professional services group, comments on UK October CPI inflation data:
UK October annual CPI inflation came in at 4.2% (consensus: +3.9), the highest rate for a decade, against 3.1% in September. The underlying core CPI inflation (excluding energy, food, alcohol and tobacco) was 3.4% (consensus: 3.1%) versus 2.9% previously. Annual CPIH inflation (including housing costs) rose 3.8% (consensus: 3.6%) versus 2.9% in September.
Inflation was generally lifted higher last month following a confluence of factors, including; i) a 12% rise in the Ofgem (the electricity regulator) utility price cap on 1 October; ii) rising petrol prices; iii) a partial reversal of VAT cuts in the hospitality sector, where costs may be passed on to customers; iv) increased global cost pressures from supply chain disruption, as evidenced in higher used car prices and v); a low base from the covid-related slowdown last year.
Given the momentum behind the price data and strengthening private demand, the risk of a higher future inflation rate remains tilted to the upside, and particularly as firms have room to raise prices as sectors are reopened. For instance, the CBI October survey of Small and Medium Enterprises showed that a record 59% net balance of respondents were raising average selling prices over those that were lowering prices.
Following the relatively healthy labour data out on Tuesday, today’s inflation release will increase the pressure on the Bank of England (BOE) to finally raise interest rates. The BOE will be aware that when it failed to raise interest rates at its 4 November meeting it weakened sterling and created another source of inflation through higher import prices. The BOE may be reluctant to make the same mistake again when the Monetary Policy Committee meets next on 16 December.
Aside from the uncertainty over whether the UK will trigger Article 16 of the Northern Ireland Protocol and sour relations with the EU, the labour and inflation data should at least limit sterling downside against major currencies somewhat. Moreover, the macro backdrop remains conducive for UK equities over bonds.
First, equities look cheap relative to bonds. The UK overall stock market dividend yield from Datastream is 3.3%. This is an historically high 2.3% point premium over 10-year Gilt yield, implying stocks trade at a sizeable discount to bonds.
Second, the IMF updated its projections in October to forecast UK real GDP (a rough indicator of revenue growth) to expand by healthy 5.0% in 2022 after a strong 6.8% expected rebound in 2021 from covid-related lockdowns the previous year.
Third, there is little evidence that company profit margins are being eroded by rising input costs (raw materials and wages). The UK MSCI forward profit margin (as a % of sales) has continued to trend upwards since troughing in June 2020 to reach 10.6% currently, its highest ratio in 14 years. The combination of strong output growth and high profit margins supports company earnings and underpins UK equities.