MONTHLY UPDATE: UK INFLATION – COOKING ON GAS

WHAT'S HAPPENING?

The UK economy continues to face headwinds, not least the prospect that inflation has yet to peak and the ongoing impact this is having on the cost-of-living crisis. Added to this, recent Consumer Price Index (CPI) forecasts have reinforced the difficult outlook for the economy over the coming months. A recent report published by Citi Bank predicted UK CPI to reach 18.6% in January 2023.

Without a doubt the biggest challenge for the UK (and Europe too) is the steady rise in energy prices, especially when compared to the US where gas prices have risen much less. The situation in the UK and Europe has been made worse by the invasion of Ukraine. Russia (the world’s leading exporter of gas) has already started restricting gas delivery and expectations are for deliveries to stop completely this winter.

A divergence in the inflation narrative

While the UK and Europe have yet to see a peak in inflation, it’s a very different story in the US.

A greater degree of energy independence has meant that the cost of gas, one of the key drivers of rising prices, has increased substantially less in the US than in other regions. We’ve also arguably seen more integrated monetary and fiscal policy in the US. The US Federal Reserve has been more decisive in raising interest rates to tackle inflation, while the government hasn’t offered any stimulus packages to its people. So, there has been a concerted effort to encourage people to spend less.

This all supports the argument that we’ve probably already seen US inflation peak.

WHAT DOES THIS MEAN FOR YOUR INVESTMENTS?

Coutts had already positioned portfolios to navigate the more challenging outlook we’re seeing in the UK. As the inflation narrative continues to dominate, the recent move to reduce our allocation to UK gilts and diversify into G7 government bonds – including US Treasuries – has helped mitigate the risk associated with holding government debt from just one country.

Coutts' sterling portfolios are also slightly underweight UK equities vs. benchmark. And earlier in the year they switched from UK mid-cap companies (which tend to be more domestically focused) to large-cap firms (which are usually more global and so benefit from weaker sterling when international earnings are repatriated). This has also proved beneficial. Additionally, with the US dollar continuing to strengthen, they are very slightly leaning towards the dollar in cash allocation in portfolios and funds.

Coutts have also recently shifted focus away from some of the UK funds which carry a higher tracking error (they can deviate to a greater degree from their benchmark). These types of funds usually invest in more mid-cap stocks which are struggling in the current, unpredictable environment.

While August continued to build on July’s market rebound for the most part, we still expect challenges to come. If this is the case, Coutts' increased allocation to cash will allow them to take advantage of attractive buying opportunities.