UK Inflation comes in hotter than expected, pushing out rate cut expectations

Spotlight: Commodities

Commodities are basic goods or raw materials that are used in the production of other goods and services. These raw materials can be categorized into several groups, including agricultural (e.g. wheat), energy (e.g. oil), metal (e.g. copper) and industrial (e.g. wool). Commodity prices are influenced by various factors, including supply and demand dynamics, geopolitical events, economic conditions, weather patterns, technological advancements, and market speculation. The prices of commodities can be volatile and have a significant impact on the cost of production, inflation, consumer prices, and global economic growth. As a result, commodity markets play a crucial role in the global economy and are closely monitored by investors and consumers alike.

The Russia-Ukraine war which began in 2022, had one of the biggest impacts on commodity prices in decades. It disrupted natural gas supply to Europe and other areas, triggering the 2022 “energy crisis”. Sanctions placed on Russia, meant countries sought supplies of commodities like coal, oil and gas from elsewhere, resulting in significant price spikes, source weforum.org. UK households were one of the most affected by this crisis in Western Europe, given their over reliance on gas to heat their homes. Rising energy costs have a knock-on effect on other goods as sellers increase their prices in line with the heightened production costs. 2023 saw energy prices come down which was largely attributed to an overproduction coinciding with low demand due to record mild winters in the northern hemisphere, source Bloomberg.com. 2023’s record of being the hottest year globally fuelled a strong performance for the price of commodities, like sugar, coffee and cocoa. The adverse weather disrupted the production of such products which led to supply shortages which in turn pushed prices up further.

Geopolitical conflicts continued into 2023 with tensions in the Middle East escalating. Attacks on ships in the Red Sea disrupted shipping and trade routes, increasing the price of crude oil and heightening the uncertainty of energy commodities supply once again. The previous energy crisis propelled the UK and other countries’ target of sourcing renewable energy alternatives. Renewable energy made notable progress last year, with several countries pledging to move away from fossil fuels in the future. During periods of increasing tensions, precious metals typically experience short-term gains. Gold, viewed as the world's “safe-haven asset”, reached a record high of $2,062 per ounce by the end of 2023 due to strong central bank purchasing, reaching levels not seen in over a decade, source Bloomberg.com. China’s decision to boost its currency and diversify away from the US dollar by purchasing 181 tons of gold, which represented 4.3% of the country’s total foreign reserves, was another strong contributor to gold’s consistent market performance, (source Forbes.com).

However, investing in commodities also comes with its own set of risks, including significant volatility, geopolitical risks, and regulatory changes. Therefore, it may be preferable that investors access a diversified portfolio of commodities via a skilled active manager, which comes at a cost. Regardless, it is essential for investors to carefully consider their investment objectives, risk tolerance, and time horizon before adding commodities to a portfolio. The chart below shows the growth of the commodities market over the last ten years, (source FactSet).

The Noise​

• China’s economy grew faster than expected in the first quarter of 2024, growing 5.3% in January-March from a year earlier, comfortably above expectations of 4.6% growth. This provided some respite to officials, as they look to bolster growth amidst prolonged weakness in the property sector and increasing local government debt. However, several other economic indicators released in March alongside GDP data – encompassing property investment, retail sales, and industry output – revealed that domestic demand continues to exhibit fragility, weighing on overall momentum.

• The UK’s unemployment rate rose unexpectedly to its highest point in six months, as the jobless rate increased to 4.2% in the three months through February. This is up from 4% in the same period through January and provides an indication that the once red-hot labour market is cooling. The data offered a tentative indication that inflationary pressures within the job market are easing. However, the report also revealed that wage growth, a closely monitored metric by the Bank of England, remained persistently high, decreasing to 6%. This is only slightly lower than the previous 6.1% and is above expectations of economists.

• Higher-for-longer interest rates may present a potential challenge for the renewable energy sector, adding difficulty to the global push for a switch to sustainable energy. Interest rates in the US, UK and other developed economies have been held at multi-decade highs since they peaked in 2023, which have meant higher borrowing costs for investors. This has a more profound impact on the renewable sector than oil and gas, as renewable projects are more capital-intensive and rely on subsidies. The longer that interest rates stay elevated, the harder it will be for net-zero targets to be achieved in the long run.

The Numbers

The Nuance

Much like the latest US inflation data released last week, UK inflation data released this week came in above expectations. Though UK inflation did slow to 3.2% in March from 3.4% in February, its lowest rate in two and a half years, economists and the Bank of England had forecasted 3.1%. Several analysts remarked that this data serves as a reminder that Britain’s fight against inflation is not yet won. Some highlighted the risk that Britain may follow the trend seen in the US and see inflation stall.

Details of the latest inflation data showed that a slowdown in food prices was the main contributor to the fall in headline inflation. Prices of food and non-alcoholic beverages increased by only 4% over the 12 months to March, their weakest rise since November 2021. Fuel prices crept higher however, as international oil prices climbed in March amid growing tensions in the Middle East. Core inflation, which excludes energy and food prices, slowed to 4.2% from 4.5% in February.

Despite expectations that the Bank of England will reduce interest rates later this year, investors on Wednesday tempered their forecasts regarding the number of adjustments. Having previously expected three cuts in 2024, markets now only fully anticipate one quarter-point cut by the end of the year, with expectations that we may need to wait until November for it. The likelihood of higher-for-longer rates growing helped lift the pound from a five-month low vs the US dollar, with sterling appreciating by as much as 0.4% following the data release. UK markets were up on Wednesday despite the hotter-than-expected inflation.

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.