UK Inflation – February 2010 Update

Yesterday the Office of National Statistics reported the January 2010 UK Consumer Price Index (CPI) as 3.5% up from 2.9% and the UK Retail Price Index (RPI) as 3.7% up from 2.4%. It seems the records just keep being broken. Last month we had “the increase in the CPI annual rate of 1.0 per cent between November and December 2009 is the largest ever increase in the annual rate between two months” and this month we have an ”increase in VAT rate leads to record CPI monthly movement for a December to January period.”

The first chart is tracking the CHAW Index which is the RPI including All Items. I focus on the RPI as my National Savings and Investments Index Linked Savings Certificates use the RPI to index from. The current level of the Index remains above the trend line however what is interesting is that the index is actually starting to fall. In December ’09 it stood at 218 and it is now at 217.9, a fall of 0.1. At first glance this might suggest that the Bank of England has it all under control and inflation is going to start falling towards their 2% CPI target. I’m not convinced as let’s look at what’s happened for the same period over the previous 10 years:
- December ’08 to January ’09, -1.8
- December ’07 to January ’08, -1.1
- December ’06 to January ’07, -1.1
- December ’05 to January ’06, -0.7
- December ’04 to January ’05, -1.0
- Then in order of the previous 5 years -0.4, -0.1, -0.1, -1.1 and -0.7

The second chart is again based on the CHAW Index. This chart shows annual figures based on the previous 3, 6 and 12 month’s worth of data. As of December the 12 month figure is 3.7% (as published by the ONS), the 6 month figure is 4.2% and the 3 month figure is 3.5% annualised. It will be interesting to see what happens next month as I still think the Bank of England are looking for all the excuses to sweet talk the market but are chasing a “little inflation”. This will ease the pain on those who are in debt. That is the government and the public who on average have over extended themselves. Those prudent savers (like myself) will of course be punished as the value of their assets is reduced.

The fact that CPI is so far above the 2% target prompted the Bank of England to write a letter to the Chancellor. What a read. Firstly the excuses:
- “the restoration of the standard rate of VAT to 17.5% is raising prices relative to a year ago.” I think it’s a little hypocritical to use this excuse. When the rate went from 17.5% to 15% a little over a year ago I don’t remember anyone using this effect to help explain why we were seeing deflation. Instead it was quick, panic, drop the Official Bank Rate to record lows and Quantitative Ease (QE). Now the boots on the other foot and we just ignore it.
- “oil prices have risen by around 70%.” Why no mention of the fact that they and the government managed to engineer a currency devaluation knowing that import prices will rise, causing the average punter to pay more for fuel, which feeds into CPI.
- “the effects of the sharp depreciation of sterling in 2007 and 2008 are continuing to feed through to consumer prices.” As mentioned above all engineered by the Bank and government and now it’s all oh well too bad at least we have an excuse.
Secondly, it is clear we should not worry as the Bank of England knows what it is doing [sic]. Inflation is well above target but the “low level of Bank Rate, will continue to provide a substantial boost to nominal spending for some time to come.” In case that wasn’t inflationary enough “it will continue to monitor the appropriate scale of the asset purchase programme and further purchases would be made should the outlook warrant them.”
Finally, “equally, if at some point in the future, the medium term outlook for inflation threatened to rise above the 2% target, the Committee would tighten monetary policy.” To me it looks like we are well above the 2% target and that’s why the Bank of England are writing the letter in the first place. The Bank of England next meets on the 04 March however this letter makes it clear. Interest rates won’t be raised and we still have the chance of yet more Quantitative Easing to come. How much more do they want to distort markets and force up asset prices through low interest rates. I hope the bond market soon stops all this nonsense and takes the decisions away from them.

It’s interesting to parallel this with another developed economy central bank. The Reserve Bank of Australia seems to have CPI in control at 2.1% after raising rates a number of times. They are clearly committed to their inflation target as the latest minutes show that the decision to hold rates last month was a close call and that rates would continue to rise in 2010 if the economy continued to grow.

One only has to look at the exchange rate between the countries today to see the attitudes of both banks demonstrated by the markets.

As I stated last month, all I can say is that I’m glad I own Index Linked Savings Certificates and Index Linked Gilts.

As always DYOR.

The Bank of England holds the Official Bank Rate at 0.5%

The Bank of England made two decisions today.

Firstly the bank decided to stop quantitative easing as they were happy with the £200 billion of government bonds that they already own. What is now going to be interesting to watch is what happens to government gilt prices and yields now that the government have lost a key buyer of their debt. In December alone the UK government needed to borrow £15.7 billion and I look forward to seeing where the buyers of all this debt are going to come from. The other thing that I look forward to is seeing if the Bank of England is ever going to be able to sell the government debt that they have already bought.

Secondly the bank decided to keep the official bank rate on hold at 0.5% for the twelfth month in a row as I suggested they would on Tuesday. This is the lowest rates have been even if I look back to the year 1694. Even during the Great Depression the Bank Rate only went as low as 2%. My chart today shows the relationship between the official bank rate, the consumer price index (CPI) and the retail prices index (RPI). Normally, as you would expect, the correlation between the official bank rate and inflation is quite high. However currently the bank seem to have lost all interest in controlling inflation so while it heads skyward the bank rate flat lines. I’d really like to know their justification for this when the Monetary Policy Framework under which they operate includes “...Price stability is defined by the Government’s inflation target of 2%. The remit recognises the role of price stability in achieving economic stability more generally, and in providing the right conditions for sustainable growth in output and employment.” I guess we’ll know Mervyn King’s thoughts when he writes a letter to Alistair Darling next month following the CPI heading over 3%.

A tale of two Central Banks – Reserve Bank of Australia vs Bank of England

The Reserve Bank of Australia (RBA) announced today that they were keeping interest rates on hold at 3.75% after raising rates by 0.25% a month for 3 months in a row. According to the Financial Times this surprised most economists.

In my opinion the RBA seem to have timed their increases well. In September of 2009 the Australian Consumer Price Index (CPI) saw a low in this cycle of 1.26% and even though this was the case they started raising rates in October. We have now seen the RBA increase rates by 20% from their lows. It doesn’t seem unreasonable to me for them to take a pause to see what effect this is having given CPI is still only 2.1% and given the inflation target for the RBA is as follows:

“The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 per cent, on average, over the cycle. This is a rate of inflation sufficiently low that it does not materially distort economic decisions in the community. Seeking to achieve this rate, on average, provides discipline for monetary policy decision-making, and serves as an anchor for private-sector inflation expectations.”

This target was introduced in mid 2003 and since that time the arithmetic average has been 2.7% so to me as a simple Average Joe they seem to be doing a reasonable job.

Now to the contrast which is the Bank of England. They have kept the Official Bank Rate at a record low of 0.5% now since March 2009. The Bank of England also saw the UK Consumer Price Index (CPI) reach a low in this cycle in September of 2009 at a rate of 1.1%. However instead of following the lead of the RBA they have sat on their hands allowing CPI to reach 1.5% in October, 1.9% in November and we now have the CPI at 2.9% (with last month being the largest month on month increase in history) and the Retail Prices Index (RPI) at 2.4%. I can’t see how they can allow this to occur given the Monetary Policy Framework under which they operate includes:

“The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target of 2%. The remit recognises the role of price stability in achieving economic stability more generally, and in providing the right conditions for sustainable growth in output and employment. The Government's inflation target is announced each year by the Chancellor of the Exchequer in the annual Budget statement.”

I think the Bank of England have now shown their hand and think they can control the inflation genie and allow “just a little bit of inflation”. I’m backing that they don’t raise interest rates this week. I guess only time will tell.

UK Property Market – January 2010 Update

I am yet to buy myself a flat or house even though the ownership of one is important to my retirement investing strategy in the longer term. The reason for this is that in my opinion UK house prices are still overvalued by a huge margin. Yesterday the Nationwide reported that average house prices had risen from £162,103 to £163,481, a rise of 0.8%, in a single month pushing house prices to yet more highs of un-affordability.

Chart 1 shows the Nationwide Historical House Prices in Real (ie inflation adjusted) terms. The Real increase is much less than that reported by the Nationwide with prices rising from only £163,140 to £163,481 as the UK Retail Prices Index (RPI) also increased by a high of 0.6% in a single month.

This chart also demonstrates that compared to average earnings property is very expensive when a ratio is created of the Nationwide Historical House Prices to the Average Earnings Index (LNMM) and it is for this reason I have yet to buy. In 1996 this ratio was as low as 607 and today the ratio stands at 1,172. If we were to return to that number the average house using the Nationwide Index would be £84,670. Will we ever get that low again?

Last month I questioned whether we may have been at the point of the ‘Return to “normal”’ phase kicking in. Chart 2 today highlights why I may have been early in my call. The red line shows the monthly average of UK resident banks interest rate of new loans secured on dwellings to households. I have taken the average of five data sets which are the floating rate, fixation <=1year, fixation >1year<=5years, fixation >5year<=10years and the fixation >10years. This interest rate had been as high as 6.3% in September 2008 (before the Bank of England panicked and lowered the Official Bank Rate to a record low of 0.5%) and then had reduced to a low of 4.2% by June 2009.

This has meant for new loans the average interest payable has reduced by a 1/3. So when a typical person walks in to a bank and asks for the maximum they can borrow the low interest rate is going to mean they can borrow more principle which will then push up house prices. The good news however is that even though the Bank of England has not moved, the Official Bank Rate the interest paid on loans is starting to increase from the low of 4.2% to 4.5% in November 2009. This will reduce affordability which unless peoples earnings start to increase should start to push house prices back down again and there is little the Bank of England can do unless they completely ignore inflation and drop interest rates even further or perform more Quantitative Easing. They clearly won’t be able to do this without risking a bond strike or hyperinflation however personally I do think they won’t raise interest rates even though inflation is rising quickly when they meet in a few days.

Chart 3 shows the annual change in Nationwide property prices and compares this with the change in the average earnings index extrapolated a couple of months to match the Nationwide time period as LNMM is still only released to November 2009. It shows that the annual change in earnings is now around 1.4% which is significantly less than the Retail Prices Index (RPI) and the increases being seen in house prices.

So in summary house prices are increasing in nominal and to a lesser extent in Real inflation adjusted terms. However in my opinion I suggest that these increases will be short lived. Salaries are increasing at a rate which is less than both inflation and house prices. Bank mortgage rates are starting to increase from their lows which will reduce the level of principle that can be borrowed. The Bank of England and government are powerless to do anything about it without risking the country as a whole. The only fear I have now is that the Bank of England holds interest rates allowing inflation to rise quickly (I think they will) resulting in nominal house price increases but stagnation in Real inflation adjusted house prices. This will be dependent on whether salaries start to increase in line with inflation. The private sector doesn’t seem in a position to do this however while government borrowing is at record highs I fear the government will listen to the Unions requests for big increases as they have an election win to try and buy.

For now I’m staying out of the housing market.

As always DYOR

Assumptions:
LNMM data is extrapolated for December ’09 and January ’10.

Stagflation and the UK Q4 GDP Numbers

Firstly, some quotes to think about:
1. "Now in Britain, we are saying, as you know, that inflation is low, interest rates are low and we expect there to be growth.” – Gordon Brown, 2008
2. "We have a strong economy, its momentum will carry us through." – Alistair Darling, 2007
3. "I think the choice is becoming pretty clear. Between a government that is determined at all times to maintain the stability and growth of the British economy. “ – Gordon Brown,2007
4. “...a weak currency arises from a weak economy which in turn is the result of a weak Government.” – Gordon Brown, 1992

So the UK today emerged from recession. What an excellent [sic] job the current government and the Bank of England has done managing the UK economy over the business cycle. Today we find that the UK economy (GDP) has grown by 0.1% in the final three months of 2009. To get these outstanding [sic] results they’ve only had to lower VAT to 15%, lower the Official Bank Rate to 0.5% (the lowest rate in the history of the Bank of England), quantitative ease to the tune of £200 billion and introduce a car scrappage scheme to name but four.

This has all resulted in:
- house prices that are within 13% of record peaks. Of course that’s great news if you’re a “hard working family”, sorry, hard working politician with multiple houses partly paid for by the tax payer.
- a heavily devalued (weak) pound.
- low returns from bank deposits / bonds for those people trying to live on savings or save for retirement.

To go with this we have the Consumer Price Index (CPI) increasing at a rate of 2.9% including the largest month on month in history and a Retail Prices Index (RPI) increasing at a rate of 2.4%.

Now I’m going to get my crystal ball out and predict how the Bank of England is going to respond. I’m betting that they will leave the Official Bank Rate on hold at 0.5%. This in turn will lead to the next big issue for UK PLC. Firstly inflation will take off, then salary inflation will start as the public sector unions negotiate first just before the election and then others join the band wagon. This will then lead to built in inflation which the Bank of England will struggle to get back in hand.

I have one word for where I think the UK economy is headed – stagflation.

To conclude I’m going to modify the four quotes above a little. “Inflation is not low”, “we do not have a strong economy”, “we do not have stability and growth” however we do have “a weak currency”.

Buying Gold

I made the decision to buy gold last week. At the close on Friday gold had come off its highs to be at $1091.50. In British pounds gold was off its November peak by about 5%. The buy was not big. I nibbled by transferring about 0.6% of my total retirement investing assets from cash held in British pounds.

So when weighing up the buy what were the pro’s that I could come up with:

1. My desired low charge portfolio has an asset allocation dedicated to commodities and more specifically to gold of 5%. As I highlighted on Monday my current low charge portfolio mainly through contributing around 60% of my gross earnings towards my retirement investing strategy had seen my actual gold holdings reduce to 2.6% portfolio. This was too low.

2. Gold in 1980 reached a real monthly average price of $1,728.

3. It looks as though inflation may be among us with the RPI leaping to 2.4%. My personal feeling is that the Bank of England will not raise interest rates to counter this so I am thinking I may need more inflation protection than I already have.

The con’s that I could come up with were:

1. I hadn’t bought gold for some time as my analysis showed that if gold was following the trend line it would have a real price of $630.

2. The average real (after inflation) price for gold since 1968 has been $599. This suggested that gold had a good chance of returning to trend in the long term.

As always DYOR.

UK Inflation – January 2010 Update

During my previous UK inflation entry I showed concern at what I saw in the data and predicted that inflation could very quickly get out of hand. That concern was justified today. Firstly let’s look at the data. The Office for National Statistics (ONS) reports the December 2009 UK Consumer Price Index (CPI) as 2.9% up from 1.9% and the UK Retail Price Index (RPI) as 2.4% up from 0.3%.

The first chart is tracking the CHAW Index which is the RPI including All Items. I focus on the RPI as my National Savings and Investments Index Linked Savings Certificates use the RPI to index from. This shows a big dip when the Bank of England dropped interest rates to historic lows however the chart shows that all the dip did was compensate for the big kick upwards that was seen from 2007. The current level of the Index has now risen above the trend line and is disturbingly starting to point more and more upwards.

The second chart is again based on the CHAW Index. This chart shows annual figures based on the previous 3, 6 and 12 month’s worth of data. As of December the 12 month figure is 2.4% (as published by the ONS) however disturbingly the 6 month figure is 4.3% and the 3 month figure is 5.0% annualised.

The Office for National Statistics reports:
“The increase in the CPI annual rate of 1.0 per cent between November and December 2009 is the largest ever increase in the annual rate between two months. This record increase is due to a number of exceptional events that took place in December 2008:
- the reduction in the standard rate of Value Added Tax (VAT) to 15 per cent from 17.5 per cent
- sharp falls in the price of oil
- pre-Christmas sales as a result of the economic downturn”

That explanation is all fine and well except the Bank of England knew all this months ago. Why then did they keep the Official Bank Rate at record lows and continue with plenty of Quantitative Easing which continued to devalue the GBP further forcing inflation into the system through increased import prices. Additionally, next month (January data) we get another big kick in inflation as the VAT increase back to 17.5% hits the data set.

The Bank of England meets on the 04 February. I think this meeting will be crucial and will really show their hand. Will they sell some debt that was bought through Quantitative Easing to support the GBP? Unlikely as who’s going to buy all that in addition to the regular record monthly amounts that the Debt Management Office is trying to get rid of. Will they raise the Official Bank Rate? I’ll be watching this carefully as if they don’t then I believe they will have chosen the inflation route to ease the pain. This would obviously only ease the pain on those who are in debt. That is the government and the public who on average have over extended themselves. Those prudent savers will of course be punished as the value of their assets is reduced.

All I can say is that I’m glad I own Index Linked Savings Certificates and Index Linked Gilts.

As always DYOR.

US Inflation – January 2009 Update

The above chart shows the Consumer Price Index (CPI-U) up to December 2010 courtesy of the Bureau of Labor Statistics. Year on year inflation has risen from 1.8% in November ’10 to 2.7% in December ‘10. This index is going to be interesting to watch because month on month the index has actually fallen -0.2%.

I have taken the liberty of dividing the chart into two sections. The first red section runs from 1871 to 1932 and the second blue section runs from 1933 to present day. I chose this break point as during 1933 the US officially ended their link to the gold standard. I think this chart demonstrates a point that government will always choose to inflate debt away at the expense of savers if given the chance. They could not do this under the gold standard.

To demonstrate this arithmetic mean inflation rates have been:
1871 to 1932 CPI = 0.5% with deflation being a regular occurrence.
1933 to Present CPI = 3.7%

The CAGR CPI from 1871 to 1932 has been 2.1%.

The Bank of England Decides – Punish the Prudent

For the eleventh month in a row the Bank of England decided to keep the Official Bank Rate at 0.5%. This is the lowest rates have been even if I look back to the year 1694. Even during the Great Depression the Bank Rate only went as low as 2%. My first chart today shows the rates going back to 1948 showing just how low the Bank have set rates compared with recent history. Additionally, the Bank also decided to continue with its £200 billion quantitative easing program with £7 billion left to spend.

To me it looks as though the Bank of England decided today to punish the prudent and to reward the reckless. Who are the reckless? Well they are those who maxed out on as much credit as they could, whether to buy houses or plasma televisions. Who are prudent? Well they are those who didn’t extend themselves and decided to save for their future. I put myself into this category as I’ve decided to save for my retirement by investing with money I have earned.

What makes me think the bank has made this decision? As I’ve already identified previously inflation is starting to take off. Annualised UK Consumer Price Index (CPI) is currently 1.9% and the UK Retail Price Index (RPI) is currently 0.3%. The second chart however shows the true inflation story. As of November while the 12 month figure is 0.3% (as published by the ONS) disturbingly the 6 month figure is 3.6% and the 3 month figure is 4.1%.

By keeping the Bank Rate at record lows, quantitative easing and other factors like the return of VAT to 17.5% can only push inflation higher. I think the Bank has decided to take the inflation route. Allow those with debts to have them magically inflated away while those with assets see them devalued.

Why did I decide to take responsibility for my own future?

US Inflation – November 2009 Update

The above chart shows the Consumer Price Index (CPI-U) up to November 2009 courtesy of the Bureau of Labor Statistics. I have taken the liberty of dividing the chart into two sections. The first red section runs from 1871 to 1932 and the second blue section runs from 1933 to present day. I chose this break point as during 1933 the US officially ended their link to the gold standard. I think this chart demonstrates a point that government will always choose to inflate debt away at the expense of savers if given the chance. They could not do this under the gold standard. To demonstrate this average inflation rates have been:
1871 to 1932, 0.5% with deflation being a regular occurrence.
1933 to Present, 3.7%

UK Inflation – November 2009 Update

The Office for National Statistics (ONS) reports the November 2009 UK Consumer Price Index (CPI) as 1.9% and the UK Retail Price Index (RPI) as 0.3%.

On the surface this sounds ok as the Bank of England has the following remit:
“The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target of 2%.” The inflation measure they use is the CPI and so why would they raise interest rates?

I however don’t like what I see when I look at the raw data and think inflation could quickly get out of hand given the very low interest rates and quantitative easing that is currently occurring.
The first chart is tracking the CHAW Index which is the RPI including All Items. I focus on the RPI as my National Savings and Investments Index Linked Savings Certificates use the RPI to index from. This saw a big dip when the Bank of England dropped interest rates to historic lows however the chart shows that all the dip did was compensate for the big kick upwards that was seen from 2007. The current level of the Index is just about on the trendline suggesting we are back to the average annual increase since 1987 which is around3.5%.

The second chart is again based on the CHAW Index. This chart shows annual figures based on the previous 3, 6 and 12 month’s worth of data. As of November the 12 month figure is 0.3% (as published by the ONS) however disturbingly the 6 month figure is 3.6% and the 3 month figure is 4.1%. It will be interesting to see the official January 2010 numbers which is 12 months from the low in the Index at January 2009 and whether the Bank of England does anything about it. My simple projections suggest this could be up to 3.7%. I’ll keep buying Index Linked Savings Certificates whenever possible if this is going to continue.