A deadly brew on the boil….

Tuesday 27th June 2017

A deadly brew on the boil….

Last week we looked at Italy and why what’s happening there could trigger a global crash….

This week our attention is focused on the kitchen here at home….

Like one of Grandma’s famous hotpots, the British economy is bubbling away on the stove. But I’m not sure it smells so good. And I can’t vouch for what it will taste like when the end-product is finally dished out.

If you want my honest opinion, I reckon some of the ingredients in the pot might turn out to upset the stomach….

  • Inflation is sprouting wings….

Mark Carney and his Bank of England (BoE) team crank the levers and push the buttons that keep the British economy on the straight and narrow….

That’s what most people believe at any rate.

Carney is the ship’s captain. He stands on the bridge, assesses conditions and the direction in which he wants to travel, and makes any necessary adjustments to the ship at exactly the right time. At least that’s the theory….

Everything is under control. Right up until the point that it isn’t….

We might well have reached that point with inflation last month. It rose to 2.9%. That’s the highest level for 4-years. And it’s over-shooting BoE forecasts and targets.

Prices are rising faster than expected or desired. The sheep is veering off course….

  • A process of adjustment….

Rising prices have effects, of course….

Consumers feel the pinch. Everyday essentials take that bit more out of the monthly budget. And consumers have that bit less disposable income to spend on other things.

Consumers get worried and lose confidence. The salary isn’t going as far as it once did. There is more month left at the end of the money than there was before.

Households make some adjustments of their own in this downbeat climate. They make decisions about what they really need and the things they can do without. They hang on to money rather than spend it.

The effects of those decisions trickle down into the wider economy. This adjustment process is underway right now….

  • Growth has flattened out again….

Figures from Visa last week tell us that during May consumers cut their spending for the first time in 4-years. Overall spending was 0.8% lower than in May 2016 – when adjusted for inflation. Sales fell by 1.9% percent from April.

Consumer spending accounts for somewhere close to 60% of GDP. When consumer spending falls, the entire economy takes the hit. We’re seeing that in GDP figures that fell from 0.7% in April to 0.2% last month.

Britain’s overall economy was already the weakest performer among G7 nations in the first quarter of this year. It is getting weaker with each month that passes. The British economy is stagnating. And the burden of rising prices is not assisting….

Perhaps it wouldn’t look quite so gloomy if wages were keeping pace with inflation. But they are not.

Inflation continues to outstrip wages. And Britain remains in the middle of what the OECD has referred to as the longest period of falling pay in 210-years.

  • The bank’s conundrum….

We’re almost 9-years on from the peak of the last global financial crisis.

Interest rates have remained stuck at the lowest levels in history across the entire period. The rate hasn’t been raised since July 2007.

But the BoE is coming under increasing pressure to lift the rate now and to offset one factor contributing to rising prices – a weak pound.

A rise in the interest rate would be expected to increase the pound’s strength against the dollar and the euro and to help take the heat out of runaway consumer prices.

The BOE had previously signaled that it wouldn’t raise rates until 2019. But at the last meeting of its monetary policy committee three of the eight members voted for a rise – compared to just one the month before.

Since then, the bank’s chief economist Andy Haldane has indicated that he might vote for an increase next time too.

We could be reaching a tipping point….

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  • Careful not to kill the patient, Mr. Carney….

There’s no way the BoE will return the interest rate to anything that might be considered a normal level – normal as viewed against the historical backdrop.

To do so would be the equivalent of throwing the elderly hospital patient into an icy lake. The frail patient would be more likely to give up the ghost completely than to start swimming with the desired strong stroke.

The economy has grown so used to cheap money – money that costs next to nothing to borrow – that any increase in the price of borrowing (or refinancing debt) is going to sting. There will be plenty of kicking, screaming and thrashing.

If interest rates go up at all, it will be in small degrees. It will be a softly, softly approach – easing the patient into the cold depths gradually; trying to acclimatize him to the new experience of bone-numbing waters without killing him.

But even small rises in the rate could prove painful to consumers, to businesses and to the wider economy – as the cost of borrowing increases and consumption declines.

The BoE might turn out to be damned if it does and equally damned if it doesn’t….

Mr. Carney always wears a lovely pair of polished shoes. But I’m not sure I’d want to be standing in them right now….

  • Householders with multiple problems….

Meanwhile, it’s probably the case that the average householder pays little or no attention to the problems facing the Bank of England.

The average householder has more than enough problems of his own to contend with. And rising prices are only one problem….

Another is debt….

Credit has been in plentiful supply since the last financial crisis and consumers have not been shy of taking advantage – racking up big deficits on overdrafts, credit cards and loans of one form or another.

Consumer credit has been growing at 10% a year in recent times….

The average household is carrying £6000 in unsecured debt – and continues to add £50 to that total every month.

  • The pigeons are coming home to roost….

Cheap credit has enabled people to keep spending – without paying the bill. But there are signs that the pigeons are coming home to roost.

The Bank of England has raised concerns about the scale of consumer spending underpinned by debt – and how easy banks and financial firms are making it for people to access more credit still.

The charity StepChange estimates that 2.9 million people in the UK are currently experiencing ‘severe’ financial debt problems….

The financial ombudsman reports an increase in complaints about payday loans….

Online complaints service, Resolver, reports a sharp increase in grievances related to debt. Martyn James, a spokesman for the service says: ‘There is a large amount of credit out there and people are trying different types of credit as a way of staying afloat….’

The consensus is that many consumers are ‘up to the line’ or ‘tapped out’. Many householders are worried that they won’t be able to keep up repayments – particularly on mortgages and store cards – in the event of even a small rise in interest rates….

This is clearly a factor that helps keep Mr. Carney awake at night. Damned if he does and damned if he doesn’t….

  • The market has its back turned….

Meanwhile the markets continue to ride high. The FTSE is still trading at the very-top-end of its 10-year range. So too the FTSE 250. Reports of new highs and record-breaking bull-runs are becoming almost common-place and monotonous.

Look at the market and all in the garden appears to be rosy – we appear to be in the middle of a veritable boom-time. But it isn’t. And we aren’t.

There are clouds overhead. But you wouldn’t know it looking at the market charts. The line just keeps on rising like a kite that has broken free of any hand that ever guided it.

There’s a marked and disconcerting disconnect between what’s happening in the economy and what is happening in the markets.

The latter is supposed to look at the former and price in what it sees. Right now, the market appears to have its back turned. It either doesn’t see anything at all or it doesn’t want to look.

Sooner rather than later, it will have to. Because what is coming cannot and will not be ignored in perpetuity. When the market is finally forced to acknowledge reality, it will have a long way to fall.

That’s how it looks from here….

I’ll be back with more next Tuesday morning.

All the best,

Dave Gibson

Money Truths