UK Inflation comes in above expectations, but what does it mean for interest rates?

Spotlight: Comparing UK and US Equity Markets

Notable differences between the UK and the US can be as subtle as leaving the ‘parking lot’ to go to the ‘grocery store’ or leaving the ‘car park’ to go to the ‘supermarket’. However, the differences extend into financial markets too. The chart below shows details of the stark difference in performance for both the UK and US over the past 10 years. The US has outperformed most markets by a huge margin, thus vastly outshining UK equities in comparison. Home country bias is a common phenomenon in investing whereby investors tend to favour investing in stocks from their own country or region. People often place greater value in familiar companies, and therefore ‘trust’, resulting in portfolios that are disproportionately weighted in domestic stocks.
 

Interestingly, by simply investing in the top 100 UK stocks, your investments end up (knowingly or otherwise) largely centred around the old economy stocks such as oil, mining, and banking which are so prevalent within UK equities. In contrast to the top sector splits within UK equities, the US equity sector split continues to be heavily weighted towards the tech sector, and in particular with the “Magnificent 7” stocks (seven of the largest tech stocks such as Apple and Nvidia) which have been riding the wave of investor sentiment towards the latest advancements in artificial intelligence and led to very strong performance. But (with a slight twist on the classic phrase) what goes up, may also go down. Therefore, by having a broader global stock selection in portfolios minimises over-reliance of a particular region or sector to continuously perform.

Whilst holding a magnifying glass to these differences between the UK and US can provide useful insight, ultimately the goal is about minimising risk. Trying to time the market or predict which country's market will outperform is challenging. A global investment strategy allows investors to benefit from the overall growth of the global economy without the need for accurate market timing. Experienced investors will know that past performance cannot reliably predict future returns. Our philosophy is that globally diversified portfolios are more likely to generate strong long-term returns with less risk along the way.
 

The Noise

• China’s economy grew 5.2% in 2024, slightly more than the official target. However, the recovery proved more precarious than many analysts and investors anticipated, with a worsening property crisis, mounting deflationary risks and subdued demand casting a shadow over the outlook for 2024. Hopes that the world’s second-largest economy would see a strong post-covid rebound dwindled as 2023 progressed. Weak consumer and business confidence, growing local government debts and a notable deceleration in global growth significantly weighed on jobs, economic activity and investment. It is likely that any true acceleration in Chinese growth will need either a major global turnaround in economic growth or more active government policy.

• Workers in Europe are hoping that this year’s pay round will help to restore incomes that were eroded by higher prices. However, the anticipated boost to their purchasing power may pose challenges to the European Central Bank’s efforts to bring inflation back to its target level of 2%. They’ve singled out wages as the single largest risk to its 18-month battle against inflation, as it expects salary growth across the euro zone of 4.6% this year, far more than the 3% pace it considers consistent with inflation at its 2% target. Pay hikes will increase costs for firms and boost household income, both factors that could push up prices and force the European Central Bank to keep rates elevated.

• The European Commission, the executive arm of the EU, is set to propose a directive advocating for a 90% reduction in the EU’s net greenhouse gas emissions by 2040, relative to 1990 levels. Setting a 2040 climate target looks to bridge the gap between its existing goals to cut net emissions 55% by 2030 and the ultimate goal of reach net zero emissions by 2050. With EU parliament elections in June, the new target is set to test the political willingness to continue Europe’s ambitious green agenda. This agenda is facing resistance from certain governments and industries concerned about the cost, despite the escalating impact climate change is having on Europe, with heightened instances of destructive heat, floods, and wildfires.

The Numbers

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The Nuance

The UK’s inflation data this week deviated from its recent trend of delivering positive surprises, as the consumer price index (CPI) rose at annual rate of 4% in December. This was up from the more than two-year-low of 3.9% in November, and higher than the 3.8% that was expected. This has knocked market expectations for an early Bank of England (BoE) rate cut. A sharp increase in tobacco duty that kicked in after the most recent Autumn Statement in November as well as a bigger impact from seasonal air fare increases contributed to the rise. There was upward pressure too from clothing and entertainment prices, which was only partially offset by slowing inflation for food and non-alcoholic drinks.

Inflation coming in above expectations though is in line with the wider global trend for December inflation data, with UK inflation now on par with France and Germany. Following the data release on Wednesday, the British pound gained strength relative to global currencies, and yields on British government bonds jumped. Simultaneously, futures on interest rates implied a roughly 60% chance that the Bank of England would initiate rate cuts by mid-May, marking a decrease from just over 80% late on Tuesday.

Former BoE policymaker Michael Saunders believes however that the latest data does not contradict the broader underlying fall in inflation. He argued that “the bigger picture is that inflation is falling more sharply overall than the Bank of England had expected a few months ago”.
 

All investment views are presented for information only and are not a personal recommendation to buy or sell. Past performance is not a reliable indicator of future returns, investing involves risk and the value of investments, and the income from them, may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.

Any views expressed are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by atomos. Any expressions of opinion are subject to change without notice.