UK economic focus: what inflation and wage data mean for stocks
City Index August 14, 2017 2:32 PM
This week sees the release of some key UK economic data points including CPI on Tuesday, labour market data on Wednesday and retail sales on Thursday.
This week sees the release of some key UK economic data points including CPI on Tuesday, labour market data on Wednesday and retail sales on Thursday. The market wants to know if the real pay squeeze on the public is having an impact on consumer spending, while we expect the data to show that the consumer is still struggling with weak wage growth and rising inflation, retail spending is expected to be maintained at current levels, at least for now.
Oil suggest further CPI pressure building
UK CPI data is expected to show that the headline rate ticked up a touch to 2.7% last month while the core rate rose to 2.5%. Both are well above the BOE’s 2% target rate. For July, the fuel component of inflation is expected to drop back, while the key driver of price growth could be how generous retailers were with the summer sales. A plethora of bargains could see limited upward pressure on prices last month. Renewed food price rises and EDF’s gas and electric price increases are expected to account for the bulk of July’s small rise in the CPI rate.
Markets care about where prices are going next, and one way to gauge this is to look at the commodity markets. The Brent crude oil price is in backwardation, where futures prices are higher than spot prices, for the first time since 2014. This is significant as it can suggest pent up demand for oil, which may put upward pressure on prices, and thus CPI down the line. Thus, if the oil price is expected to move higher, how can investors prepare for a period of even higher inflation?
Value vs. Growth, why it’s not that easy
When it comes to stocks, the impact on inflation is not straight forward, particularly when interest rates are at rock bottom levels as they are in the UK. Usually, when inflation is rising this is good news for value stocks – stocks that generate cash now – which include some of the big blue chips and more stable companies. In contrast, in periods of low inflation you get growth companies – that generate cash down the line – doing well. But, even though the UK has above target inflation, growth companies are benefitting from low interest rates, which is why the UK’s AIM market has had a stonking year, as you can see in the chart below.
Thus, even in the current inflationary environment, value over growth stocks may not be the best strategy unless we see a period of intense risk aversion. It is also natural to assume that dividend stocks would be out of favour if prices are rising, however, with yield so difficult to find UK dividend payers are also in demand, even if inflation is eroding real dividend income.
Oil companies could benefit
Oil companies could also be in focus if the backwardation pattern in the Brent oil futures market is a sign that the oil price could rise in the future. This has yet to impact the stock price of the major oil companies like BP and Shell, which are lingering close to recent lows. However, a rising oil price is good news for their revenues, and we could see oil companies’ rise alongside inflation if the oil price picks up down the line.
Retail sales and the FTSE 100
Consumer stocks are also sensitive to inflation data. This week we get some important information about the UK consumer: 1, the real squeeze on incomes, and 2, retail sales for July. The market is expecting no change in earnings data for June, if expectations for a rise in CPI to 2.7% is correct, then real income growth would be contracting at approx. -0.7%. The Bank of England has already said in its latest Inflation Report that earnings growth would be negative for the rest of this year, so the bigger shock would be a decent reading of UK retail sales on Thursday even if real incomes are contracting. The market expects only a 0.1% increase in retail sales for July, the annual rate is expected to contract to 1.2% from 3%. The market is prepped to expect a weakened consumer to cut back on their spending, thus the bigger risk for stock prices could actually be a surprise bounce in retail sales for July. This is a contrarian call, the market is not expecting it and so it is a low probability but high risk event. If retail sales do bounce more than expected then this could boost the entire FTSE 100 index since the consumer discretionary sector makes up a decent 8% of the entire index, it may also have a positive impact companies such as Tui, M&S, Kingfisher, Next, Sky, Merlin Entertainment and Whitbread.
Chart 1: UK AIM 100 index of growth stocks year-to-date performance
Source: City Index
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