Inflation Hits 4.2% ... Unemployment falls to 4.3% ... Is it time to talk about overheating ...

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Subject: Inflation Hits 4.2% ... Unemployment falls to 4.3% ... Is it time to talk about overheating ...

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Saturday 20th November 2021

Hi Friend,

Inflation Hits 4.2% ... Unemployment Falls to 4.3% ...

Is it time to talk about overheating ... ?.

UK inflation CPI basis hit 4.2% in October. That's a big rise from the September level of 3.1%. Goods inflation increased to 4.9%. Service sector inflation jumped to 3.2%.

Energy and fuel dominate the cost curve. Electricity, gas and other fuels were up by 28%. Fuel costs were up by 20%. Transport costs were up by 10%.

Second hand car prices were up by 23%. Durable goods, including furniture and household appliances, were up by 10% and 7% respectively.

For the moment, food prices remain below the 2% inflation target threshold. The Bank is forecasting inflation to rise to 4.5% in the final quarter, peaking at around 5% in April 2022, then averaging just over 3% for the year as a whole.

This remains a fair call assuming energy costs and shipping costs ease back. Brent Crude closed below the $80 dollar level this week at $78.35. The cost of shipping a container from China to the U.S. West Coast dropped to $14,000 dollars from a peak of $21,000 in September.

Producer Prices ...

UK producer prices increased in October. Input costs were up by 13%. Oil prices were up by almost 90%. Metal prices were up by 20%. Chemical prices were up by over 12%. Output prices increased by 8%. The pass through rate, from input to output cost, was 61%. We model the pass through rate at 50% using long run data. The impact on goods inflation would be a rise to over 5% in the short term.

Assuming service sector inflation averages 3.5% over the period. CPI inflation would peak at between 4.5% and 5%. The good news, oil prices are easing back below $80. In any case, the inflation impact wanes into the second quarter next year, as the year on year comparisons fade.

Labour Market ...

The latest jobs data confirms the strength of the recovery. The unemployment rate fell to 4.3%. Vacancies increased to 1.2 million. There were 32.5 million in work. Earnings increased by 5.8%. There were 1.1 million on furlough at the end of September. The expectation rises, there will be no significant increase in unemployment before the end of the year.

So is it time to talk about overheating? Not yet. Retail sales were up by 5% compared to October 2019. In value terms sales were up by 10% compared to pre lock-down levels. Vibrant but not vibrating. No real need to tighten rates just yet ...

Interest Rate Rises May Be Steeper ...

This week, Christine Lagarde President of the EU Central Bank, suggested there would be no increase in Euro base rates in 2022.

In the U.S., Fed Governor Christopher Waller argued the Fed should accelerate the tempo of tapering, with an end to further asset purchases by April.

Huw Pill, the Chief Economist at the Bank of England raised the prospect the first UK rate rise could be steeper than the 15 basis point rise currently priced into markets. Governor Andrew Bailey admitted he remains "concerned about inflation". Markets begin to think a rate rise before Christmas could be a possibility.

We have argued inflation, driven by energy costs, will be a transitional phenomenon. Wage costs will level out. The disruption of lock down created a "Seismic Event" . One in which the tectonic plates of demand and supply were pushed out of balance, as demand recovery surged ahead of supply impeded.

The US economy faces the problem of the same "seismic event" compounded by the trillions of dollars spent by government to support the US economy. The largesse including "Helicopter Money" has augmented the demand shock. Our chart of the week is courtesy of Bridgewater. Growth in US nominal demand is way ahead of the global production of goods for U.S. consumers, increasing price pressures.

Fed spending was $2.8 trillion dollars in the financial year ending September. US CPI inflation hit 6.2% in October. In the US, the seismic event was followed by the Tsunami of easy money. The Fed may have to taper faster and raise rates sooner, than markets expect.

Despite the comments from Huw Pill this week, markets are now plotting an increase in rates to 0.25 early next year, rising to perhaps 1% by the end of the year. Our modified Taylor rule suggests rates could rise to 1.5% by the end of the year.

Too soon to worry about overheating. Not too soon to outline the rate rise options. The synchronized swim with Europe would suggest no rate rise at all in 2022. Our modified Taylor rule suggest are rise to 1.5% by the end of the year.

Our escape from Planet ZIRP would suggest a return to pre 2008 rules. Inflation at 2%. Base rates at over 4% and ten year gilts at 4.5% over the medium term. That's a risk based scenario option, not our central planning forecast ...

That's all for this week. Have a great weekend and a great week ahead, Don't miss our Monday Morning Markets. The open rates are now as high as The Saturday Economist. Also coming soon our "OK Boomer" series, a purchase guide to NFTs, retail Investor Apes, and the street lingo of the new traders ... Will Bitcoin hit $500,000 dollars as some fans expect ...

John

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Subject: Inflation Hits 4.2% ... Unemployment falls to 4.3% ... Is it time to talk about overheating ...