20 July 2016

Pound down, inflation up

At least one of the uncertainties created by the unexpected vote to leave the European Union has been eliminated.

We now have a new prime minister, with the swift leadership change at the top of the Conservative party allowing the creation of a new cabinet, with an emphasis on man aging our exit. The pound reacted well to the news, recovering some lost ground, though still languishing well below the pre-referendum levels.

The level of the pound will have important implications for the future. The inflation numbers published recently, which were compiled ahead of the referendum, disclosed a bigger jump in the Consumer Price Index (CPI) than had been expected. While a rise of 0.5% still puts the increase in the cost of living well below the government’s target of 2%, a modest fall in sterling in the run up to the vote will have added to these inflationary pressures.

Inflation could well be driven higher by a weaker currency. Many goods are priced in dollars, the most notable being oil, which had already staged something of a recovery. The price of oil affects many other items in the cost of living basket, with transportation costs being a crucial component of so many goods. With the fall in many commodity prices no longer providing a dampening effect on inflation, we could start to see further increases as a consequence of dearer imported goods, not to mention dearer distribution costs here.

This could well explain why the Bank of England shied away from reducing interest rates last week, despite indications from Governor that help for the economy would be on the way following the Leave vote. As it happened, Mark Carney voted against a rate rise. The usual weapon to combat rising inflation is higher interest rates, so we could well have seen a cut, from what is anyway an historically low level, reversed in short order.

Meanwhile, company news is thin on the ground, though takeover activity looks as though it could be on the up. News that one of our leading technology companies could be swallowed by a Japanese concern received a mixed reaction. The Government, naturally, cited that this demonstrated Britain remained attractive to overseas investors. The truth is that t his is also a potential consequence of lower sterling. Companies eyeing up targets here find they are that much cheaper to buy. We should expect more of this.

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