London Session: UK Prices add Issult to Injury for Households

UK inflation data surged in September, headline inflation rose 0.6 per cent on the month to 5.2 per cent. This is the highest level of CPI apart from when it reached 5.2% three years ago. The main upward pressure on prices came from gas and electricity charges, however clothing and household price increases also weighed on the index. The retail price index (RPI) – considered one of the best measures of inflation since it focuses on consumed goods and thus is a good reflection of price changes for households - surged to 5.6%, which is the highest level for 20-years.

Overall, the detail of the index was bad news for consumers. Clothing and footware prices have risen by 4.4 per cent between August and September, which is lower than last year, but still one of the largest monthly increases for this sector. Added to this, food and non-alcoholic beverages have risen 6.4% year to date. This is only going to weaken an already hobbled UK consumer who is trying to de-lever at the same time as prices and unemployment are rising.

This explains the tricky position the Bank of England finds itself in. Although rate hikes may weigh on inflation it could tip the fragile UK economy into recession. So the BOE may have to wait until inflation levels normalise, which may boost consumption and thus growth before it can even think of tightening. Today’s data doesn’t reduce the chance of more QE, it just darkens the outlook for the economy, which is why sterling is likely to remain under pressure for the medium-term, especially against the US dollar, which is currently testing support at 1.5720.

Last week we said that GBPAUD was the best trade to see the effects of QE2 on sterling. However, this trade only works in a stable market environment because of the Aussie’s high beta to risk. Thus, in an environment of risk aversion then GBPUSD should come under pressure.

Pressure continues to mount on the Eurozone. The last two weeks have seen optimism grow that a solution to the sovereign crisis would be found at this weekend’s EU summit. Yet as we edge closer to the 23rd concrete details have failed to emerge and instead roadblocks are beginning to appear. The first of these came into view yesterday with Germany tempering expectations for a swift solution this weekend. Then Moody’s came out at the US close last night and said that France’s credit rating was on review. It reiterated that its public debt dynamics are weaker than its other triple-A rated friends, which suggests that France’s days with a top credit rating could be numbered.

This is a major spanner in the works for enlarging the EFSF, one of the pillars of the 5-point plan to solve the crisis and stabilise Italian and Spanish debt. Firstly, If the EFSF is expanded to the rumoured EUR2trillion mark that would require further guarantees from Eurozone members including France who would be on the hook for a large portion of the extra funds. Secondly, if France, as a major guarantor of the EFSF, loses its triple A rating this could threaten the EFSF’s top rating, which could jeopardise the whole rescue effort.

So as you can see, there are more than just wrinkles that need to be ironed out this weekend, there are still major structural challenges to “solving” the Eurozone, and the cure for Italy and Spain could be the curse for a country like France.

Economic data hasn’t helped sentiment today. Firstly, Chinese GDP fell to a two-year low of 9.1%. This isn’t disasterous by any means but it adds pressure to global growth expectations for this year, especially since the West, led by the Eurozone, is expected to experience sluggish growth for the foreseeable future. The German investor sentiment index also dipped to its lowest level for 11 months in October. The ZEW tends to fall when volatility is high, however the forward-looking economic sentiment index dipped more than expected to -48.3 from -43.3 in September, which is far below its long-term average and reflects low expectations for growth in Germany going forward. The ZEW Institute noted that domestic data and weak retail sales have also started to weigh on investors sentiment, which is bad news for Europe’s largest economy.

Overall, Europe is still centre stage; however fears are emanating from the core rather than the periphery. It’s a big week for the Eurozone, Greece has a Parliamentary vote on Thursday to pass more austerity, which is necessary to release future bailout funds and stave off default. Depending how this goes, there may be a lid on sentiment in the near-term. A caveat to this is that market action has been extremely jittery and sentiment-driven in recent weeks. We have already noted that real money remains on the side-lines and volumes are fairly thin, suggesting there is a lack of conviction in the market. Thus if we get too extended to the downside we could see a pullback and some vicious ranges going forward.

Look out for US producer prices later, the Fed’s Bernanke who is speaking at 1730 BST and Q3 earnings reports from Goldman Sachs and Apple.