Buchler Phillips Quarterly Bulletin No.6

An inflated view of their worth

Footballers probably don’t worry too much about inflation. Top players are fabulously wealthy and their demand for most goods and services is relatively inelastic. But even the ‘beautiful game’ is distorted by inflation when you look at the effect it has on the eye-watering transfer fees paid to soccer superstars.

Paul Pogba’s world record signing to Manchester United for £89m this year falls to only third place when adjusted for inflation since Christiano Ronaldo was worth £80m in 2009. Earlier record holder Zinedine Zidane of France and Real Madrid would have seen his £46m fee from 2001 grow to £64m by now. OK, we can debate whether Pogba is 40% better than Zidane at today’s prices, but one thing’s for sure: inflation moves the goal posts.

That’s why markets get spooked and UK businesses fear the spectre of inflation. After years of worrying about prices falling globally, prompted by lower oil and energy costs, this year’s rise by a third of the dollar price of oil had already begun to cast a shadow over headline inflation rates. Now the effect in the UK is being fast-fowarded by the fall in the pound after Brexit, meaning a doubling of the sterling oil price and rising import prices expected to drive inflation higher for at least the next 18 months.

Fail to prepare and prepare to fail

The UK’s 5.5 million SMEs employ 60% of all private sector workers. The ability of these companies to invest, plan, hire and expand is vital to the health of the UK economy. At the same time, their own health is highly exposed to the vagaries of currencies, inflation and other external factors beyond their control. They don’t enjoy the relative flexibility, reserves and access to funding of large listed companies, so they are hit hardest when times are tough.

For SME’s, ‘economic impact’ means, more often than not, whether they survive weak conditions. Some 632 companies were subject to compulsory liquidation in Q3 2016, up 2.4% on the same period in 2015.  Stability, as far as possible, is key to the decision making process for businesses. Faced with volatility, unlike many institutional investors able just to sit on their hands, they have to make tough calls. Tight cash management, firm and attentive leadership and willingness for reinvention will be the hallmarks of SMEs able to last the distance.

Baby, it’s cold outside

In a different sense, high street retailers like to feel a chill wind blowing. An unusually cold mid-autumn boosted clothing sales and helped October retail figures overall grow at their fastest rate since April 2002. Total high street and online sales were £30.8bn, up 7.4% on a year ago, and up 1.9% on September. The Black Friday weekend will have artificially boosted November, but retail bosses remain cautious amid an outlook for spending that is dull at best. This year, to the end of October, 22 UK retailers have failed, with 1,250 stores and 24,488 affected. The numbers go far beyond Austin Reed and BHS combined, with high street administrations expected to remain high.

No signs of respite for stricken food retailers either. Following Tesco’s ‘Marmitegate’ spat with Unilever over sharing the pain on higher supply costs, Sainsbury’s posted a 10% fall in half year profits during November, warning of more pain to come. Already squeezed by growing German discounters, UK supermarkets have rapidly shrinking room for manoeuvre on prices. Expect their next move to affect pay and jobs: of the 2.7m workers employed by UK retail, the Big 4 supermarket chains employ more than a third.

Homes under the hammer

UK house prices face slower growth and may dip in 2017. An already overheated market in the South East is also likely to feel pressure from the increasing gap between earnings and house prices and tighter mortgage lender criteria. The fundamentals for households are definitely softening and uncertainty abounds. But is there a safety net for this key economic indicator in the form of a chronic housing shortage and wider plans for infrastructure? Very possibly. Most residential property ‘bears’ won’t commit to forecasting price falls of more than 3% next year. The Chancellor’s Autumn Statement in November dished out an additional £2.3bn for a Housing Infrastructure Fund and £1.4bn for 40,000 affordable homes. The Conservative Party Conference also unveiled £2bn of extra government borrowing to accelerate construction on public sector land. Based on overwhelming long term demand, the chances of a return to the post-boom negative equity of the early 1990s seem very slim. The comfort of confidence in property prices should help to provide a floor for UK consumer confidence overall.

UK outlook – can umbrellas cause rain?

At least one Bank of England rate-setter thinks not. Gertjan Vlieghe, one of the strongest advocates for Bank of England stimulus before and after June's Brexit vote, says the BoE should be in no hurry to either cut or raise rates. He reckons that inflation poised to overshoot the BoE’s target by half a percentage point is tolerable. Tightening with a rate hike has no ceiling, but there is less scope to ease. The balance of economic commentators still believes that low interest rates are a symptom of problems in the global economy, not a cause. So sterling’s impact on inflation is set to be allowed to run its course. Nor does the Old Lady have much sympathy for rate-starved savers – many of their assets have benefited from the low interest rate environment.

The hope is that eventual good news on the economy could push up the value of the pound and therefore reduce inflation pressure, allowing interest rates to stay low. Whether you were for or against Brexit, the threat of the UK plunging into immediate recession after the vote did not materialise. In headline terms, the OECD expects UK GDP growth of 2% this year and 1.2% in 2017, both upgraded by the global think tank since September. It also predicts that UK plc will outperform the Eurozone over the next decade, despite highlighting signs that growth is cooling. There is undoubtedly pressure building on pay as the pound hits many other corporate costs. Higher consumer prices and lack of salary increases certainly won’t help consumption. Overall there is little cause for cheer, but even the strongest economic binoculars struggle to predict a collapse at home.