INFLATION TAKES CENTRE STAGE ONCE MORE AS TORY LEADERSHIP RACE ENTERS THE FINAL LEG

INFLATION TAKES CENTRE STAGE ONCE MORE AS TORY LEADERSHIP RACE ENTERS THE FINAL LEG

This week the main story in markets has been inflation as the European Central Bank increased interest rates for the first time in 11 years and CPI in the UK rose again. Both exceeded expectations but neither generated a significant reaction. Other data out this week is more interesting. Current vacancies are at a record high of 1.3m but there are signs that some of the people who left the labour market are at last returning, while wage growth remains below inflation. The lack of wage inflation means the Bank of England has some leeway at next interest rate meeting.

Elsewhere, the battle to become the next prime minister heads into its final stage. The next five weeks will see former chancellor Rishi Sunak hoping everyone forgets he was one of the first cabinet members to stick the knife in Boris Johnson. Meanwhile Liz Truss is trying to make a lot of ground by criticising the last 20 years’ management of the economy. She’ll be hoping no one remembers the Tories have been in power since 2010 and she was Chief Secretary to the Treasury during this period.

The ECB also said it was able to raise rates faster than expected as it has agreed details of its new bond-buying programme. This scheme is designed to prevent a sell-off in the debt of countries like Italy and Greece which is more vulnerable to rising interest rates. The ECB’s task could be made harder after Italy’s prime minister Mario Draghi’s resigned after losing a confidence vote. The ECB’s decision caused the yield on German 10-year government bonds to rise 0.1% but the yield on Italian government bonds increased 0.24% to 3.6%.

UK: CPI RISES AGAIN BUT INFLATION SHOWS SIGNS OF NARROWING

UK Inflation rose again in June as CPI hit 9.4%. The increase is mainly being driven by the sharp rise in household energy bills and petrol and diesel prices. Core inflation (excluding food and energy costs) fell slightly for the second month in a row. The Bank of England has responded to rising inflation by floating the possibility of a larger-than-expected 0.5% hike in August.

Rising inflation is driving up the cost of servicing UK government debt. The monthly interest bill hit £19.4bn in June, almost double the £10.1bn cost in June 2021. This surge in cost may play a part in the race to become the next prime minister. Former chancellor Rishi Sunak led the MPs’ vote and favours higher taxes to deal with some of the costs of Covid but he currently trails Liz Truss in polls of Conservative party members. Truss is strongly in favour of tax cuts to ease the cost of living crisis and a Truss victory has been tipped to push down sterling.

EQUITIES: PROFIT WARNINGS RISE AS CONSUMER SPENDING FALLS

This week brought profit warnings from Deliveroo, Made.com and pub-group Mitchells & Butler as they feel the effect of rising costs and deteriorating economic outlook. Last week saw Wetherspoons and soft drink-maker Fever-Tree also downgrade their forecasts. One contributory factor is the squeeze on disposable incomes as Made.com warned of a decline in big ticket spending as consumers become more pessimistic. After inflation regular earnings fell by a record 2.9% between March and May.

Profit warnings have not been restricted to sectors dependent on consumer spending. Direct Line reduced its forecast while insurer Sabre issued a similar warning earlier this month. The UK has seen fewer profit warnings than the US and Europe this year and the number of downward revisions appears in line with the pre-Covid average. This could be due to UK companies starting with a more pessimistic outlook or the FTSE weighing heavily towards energy and mining companies, which have been benefiting from high commodity prices.