Mar­kets cast doubt on UK’s in­fla­tion goals

Kuwait Times - - BUSINESS -

LON­DON:

If fi­nan­cial mar­ket gauges are to be be­lieved, Bri­tain will strug­gle to keep in­fla­tion in check for the next half cen­tury. Those sig­nals are likely dis­torted by other fac­tors, but they are con­tribut­ing to ques­tions over the Bank of Eng­land’s abil­ity to con­tain in­fla­tion as Bri­tain pre­pares for an era of eco­nomic un­cer­tainty out­side of the Euro­pean Union. Hav­ing watched ster­ling crash to a 31-year low against the US dol­lar on Brexit fears, the BoE will likely next week jack up its in­fla­tion fore­cast to show a big­ger over­shoot of its price tar­get than any time since it gained in­de­pen­dence in 1997.

In its Au­gust fore­casts, the BoE al­ready pre­dicted in­fla­tion of 2.4 per­cent in two and three years’ time, above its 2 per­cent tar­get. Since then, ster­ling has fallen fur­ther on wor­ries that Bri­tain will take a hard­line ap­proach to the Brexit talks. For Bri­tain’s mon­e­tary guardians, deal­ing with ris­ing in­fla­tion could be dif­fi­cult. Its ul­tra-easy ap­proach has been crit­i­cized by some law­mak­ers while tight­en­ing con­di­tions could risk chok­ing off eco­nomic prospects al­to­gether.

Econ­o­mists are keep­ing a fairly cool head on near-term price prospects for now, and no one is ex­pect­ing a re­turn to the dou­ble digit in­fla­tion of the 1970s and 1980s. Like cen­tral bankers, they tend to look through blips caused by fac­tors such as cur­rency de­pre­ci­a­tion. But long-term wor­ries are cre­at­ing some con­cerns among in­vestors. “The long-term in­fla­tion fore­casts are high and that then in­creases the ur­gency of hav­ing to pro­tect your­self against in­fla­tion, so it can be­come a vi­cious cir­cle,” said John Wal­baum, head of in­vest­ment at con­sul­tancy Hy­mans Robert­son.

Over the past decade, in­fla­tion has over­shot the BoE’s tar­get eight times, and by more than 0.5 per­cent on five oc­ca­sions, ac­cord­ing to the Of­fice for Na­tional Sta­tis­tics. Sev­eral econ­o­mists with lead­ing in­ter­na­tional banks have said they ex­pect prices to peak around 3 per­cent at the end of 2017, lower than 5 per­cent seen af­ter the fi­nan­cial cri­sis and bouts of more than 15 per­cent seen in the 1970s and 1980s.

For longer-term fore­casts, mar­ket pric­ing is seen as one of the only sig­nals, specif­i­cally breakeven rates on in­fla­tion-linked bonds. Breakeven rates the dif­fer­ence be­tween real yields on in­fla­tion­linked bonds and nom­i­nal bond yields - in­di­cate the av­er­age rate of in­fla­tion needed for an in­fla­tion-linked bond to be a bet­ter in­vest­ment than the reg­u­lar bond.

In­fla­tion-linked bonds are in­dexed to re­tail prices, which econ­o­mists say is roughly around 1 per­cent higher than con­sumer prices, im­ply­ing that a breakeven rate of around 3 per­cent sug­gests the BoE is hit­ting its tar­get. Fifty-year breakeven rates are cur­rently around 3.5 per­cent. Some econ­o­mists say the fall in the cur­rency since the Brexit vote is likely to blame, rais­ing the risk that av­er­age in­fla­tion rates could stay el­e­vated for many years. “The mar­ket is pric­ing in a short-term over­shoot in in­fla­tion and that may be re­flected all across the curve, even at ma­tu­ri­ties that you may not ex­pect,” said Sam Hill, se­nior UK econ­o­mist at RBC Cap­i­tal Mar­kets.

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