Market Update 13th November 2023

Inflated uncertainties

It’s hard to start any commentary about what’s going on in the world without pausing for thought to reflect on the dreadful events in the Middle East, and our hearts go out to the innocent children and families caught up in both sides of the fighting.  There were glimmers of hope last week. First, with Israelis announcing daily pauses in military action to allow for humanitarian aid for Gazan civilians, and second, the US communicating its thinking about what comes after the conflict and how a satisfactory solution needs to be found for the future of Gaza. There were however also points of potential escalation into a wider conflict, with pockets of trouble erupting in the West Bank, and the US and Israel both participating in military exchanges in Syria. Perhaps the only positive one can take at this point is what’s not happened, as fears of a wider escalation across the Middle East (and further still), have so far remained contained. For global markets and investors, escalation would likely bring a squeeze in oil prices and another round of inflationary pressures.

Inflation will be front and centre again this week with the US CPI release on Tuesday and the UK print on Wednesday. Consensus expectations are that the US headline number will come in at 3.3%. For the UK, we should see a sharp fall in the headline rate, with consensus estimates currently at 4.8%. This is quite a step down from the 6.7% rate in September (and a huge helping hand towards Mr Sunak achieving his goal of halving inflation by the end of the year).  However, this shift down will be largely due to the base effect, whereby an earlier leap in inflation over a year ago now (due to the significant jumps in energy prices) will fall out of the numbers this time around, rather than this being due to the Prime Minister and his Chancellor.

However, before we get too excited that the inflation dragon has almost been slain, the consensus estimates for UK core inflation (ie excluding more volatile short term prices such as energy and food prices) is still up close to 6% at 5.8%. When we look more closely at the breakdown of the components of the inflation measure, this is still largely being driven by inflation in the services sector, which remains robust.

One of the key drivers of this sticky inflation has been wage growth, and the private sector in particular, has been increasing wages at rates much closer to headline inflation. Psychologically though, if the headline number is coming down, perhaps this will begin to break this wage-inflation cycle.

There were a couple of indirect developments last week that perhaps help us piece together a picture of where core inflation might be heading. With much relief to anyone planning on using the rail network over the festive period, UK train companies have reached an initial agreement with the RMT Union to call off the next round of strikes (still to be put to a member vote). The backdated pay rise of 5% for 2022/23 that’s been agreed, may set a subliminal bar for wider wage negotiations. (Rail users will be eager to see what unfolds when they get to the 2023/24 negotiation).

The other indirect inflation driver was the latest China CPI number, which came in at -0.2%, ie outright deflation. With China so interconnected with the rest of the world this puts downward pressure on global prices.

If energy prices remain behaved, then perhaps we’re seeing signs that inflationary pressures are subsiding gradually. This may allow Central Banks to have to think less about whether more interest rate hikes are necessary, but instead starting the conversation about lowering rates.

Simon Reynolds – Head of Research

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