Fiscal policy it’s quite a tough nut to crack. In fact, the most common measure known as the DEBT/GDP ratio can be quite funny. In fact, even without increasing debt, if the GDP component shrinks, that would increase the DEBT/GDP % ratio.
Like most other developed Countries, the UK economy could be drawn out with this graph. STAGFLATION=negative output gap, and high Inflation. There are things that you can do during STAGFLATIONARY times, such as reducing the V.A.T. burden on prices balanced with raising Fiscal revenues.
The UK economy has one of the highest Inflation rates with CPI Inflation 11.1%, while the CORE Inflation rate in October increased to 6.5%, both Inflation measures were well unanchored from the BoE 2.0% price stability remit. Although the BoE presumes Inflation to peak in Q4/22
This table from the ONS becomes very important to have a gauge of the composition of the Inflationary pressure in the UK economy. Double-Digit increases in prices have been driven by Food&Beverage Demand, Housing & Household services, Household goods, and Transport,
The aggregate measure of price increases has jumped from 13.2% to 14.8% in one month only and the Pound exchange rate effect on prices also has to be factored in. However, the most important data becomes the CPIH (excluding everything else) a concise measure of CORE prices.
Why the CPIH data becomes important?
In October CORE economic activities price inflation= 5.8%, compared to 2021 same CPIH= 0.6%. This data becomes important because can derive with some due approximation the 5y5y Breakeven Inflation measure, according to this data CPIH 5.2%. The 5y5y Breakeven Inflation rate serves as a forward measuring data of Inflation expectations. The CPIH data has jumped 5.2% in the span of 12 months, that means UK INFLATION expectations have become unanchored, and the BoE seems not to have any grip on price stability.
The 5y5y Breakeven Inflation data goes back to the Government macro-economic development assumptions for the UK economy and Inflation. First of all the Government CPI data for 2022, it’s wrong CPI=11.1% not 9.1%, wrong 2.0%. Forecast Inflation of 7.4% in 2023 and 0.6% in 2024 both could be wrong.
Most of the UK inputs for the most Inflationary data are imported food supplies, meanwhile, the +10% Housing and Household services inflation are determined by asset prices inflation in the housing market. CORE Consumer Inflation expectations have increased by 5.2% to 5.8%.
Inflation Expectations in the United Kingdom remained unchanged at 6.20 percent in October from 6.20 percent in September 2022.
Inflation Expectations in the United Kingdom are expected to be 8.40% by the end of this quarter, according to Trading Economics global macro models and analysts expectations. In the long term, the United Kingdom Inflation Expectations are projected to trend around 2.30% in 2023 and 2.00% in 2024, according to our econometric models.
With broad CORE Inflation at 6.5% in October/22, would be very difficult that CPI Inflation in 2023 decreases to 7.4% on average, but the most difficult data are 2024 onward Government Inflation forecast of 0.6%, not attainable -0.8% in 2025. That’s because the 5y5y Inflation expectations currently stand at 5.2%, on a 5 Year horizon and Inflation Expectations are 6.2% for 2022, that could peak at 8.4% in Q4, while forecast to decrease to 2.3% and to 2.0%.
Why the Government Budget Inflation forecast mistakes are important?
Because Inflation measures are a core part of the Bank of England monetary policy decision-making, but most importantly the Government Inflation forecast mistake and misunderstanding of the global economic development going forward, do hinge on the GILTs market and the Debt Interest servicing budgeted going forward.
The UK DMO and the Government have issued £373,09 Billion Pounds of INFLATION-INDEXED-LINKED GILTs. A Fiscal policy debt management blunder, for a nation, that imports most if not all of its basic consumer goods and where the economic structure has been based on continuous Trade Balance Deficits.
The INFLATION-INDEXED-LINKED-GILTs premia have ballooned to £564,49 BillionPound, a (£191) Billion-pound gap that the Exchequer and DMO have to manage and that frankly have very blindly created with INFLATION-LINKED-GILTs-ISSUANCE. This goes back to the Government Budget Forecast for Inflation in the economy. Considering that Inflation would be higher and persistent in the economy going forward, the INFLATION-INDEXED-LINKED-GILTs premia would not easily deflate and that will continue to drain off Fiscal Revenues from the Exchequer.
The Bank of England monetary policy framework doesn’t seem fully priced in the interest rate tool the forward-looking measures of Inflation. In fact, for the BoE the Stagflation=Inflation conundrum has become a very difficult monetary policy balancing act. Only a hint of Quantitative Tightening and BoE Balance sheet shrinking did have enormous spillover effects in the GILTs market and the Pound, that’s also due to intrinsic leverage built-in UK Investment Funds. This makes the Bank of England’s monetary policy quite ineffective and the Bank will have to redress for its monetary policy framework the Inflation forecast projections and the 5y5y inflation breakevens. The Bank of England has become stuck with its monetary policy decision making and they are blindly waiting for Inflation to decrease globally while ignoring that the UK economy functions on Trade Deficits and imports almost everything to generate economic output and consumption.
The Graph below it’s the UK Balance of Trade for the past 25 years
Bank of England SONIA Rates curve do continue to offer lower rates for the 30 days, 90 days, and 180 days Sterling Money Market debt and refinancing rates
The GILT market and the Yield curve for all maturities seem to have stabilized to levels between 3.0% and 3.5% that signal discounting similar future levels of inflation rate in the economy
The SONIA Swaps curve becomes also a measure of how Sterling debt markets have been pricing the possible 5y5y Breakeven Inflation rate going forward
The 3-Months SONIA forward curve also prices in higher inflation and higher interest rates.
Indeed, because of the 100 basis points differential, the daily SONIA rates, the Bank of England interest rate could be forecast to peak at 5.5%
Why Debt Leverage and Inflation are a toxic cocktail for the economy?
Quite simply, most inflationary pressures come from households often leveraged households. Inflated economies on cheap debt and mispriced assets won’t see Inflation decreasing until the Housing market deflates, that would require the Bank of England to raise interest rates to levels very similar to the UK Inflation rate until the Housing market and the Building Developers’ Commercial properties’ speculative debt leverage investment deflates and slows down.