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L’Action de grâce est le moment de l’année où nous réfléchissons aux aspects heureux de notre vie et témoignons de notre reconnaissance envers nos amis, notre famille et ceux qui nous soutiennent. Chez CC&L, nous sommes reconnaissants pour nos banques alimentaires locales et pour l’aide qu’elles continuent d’apporter dans les collectivités où nous vivons et travaillons. 

Les banques alimentaires ont joué un rôle essentiel dans la vie de nombreuses personnes, en particulier parce que la COVID-19 a entraîné davantage d’insécurité alimentaire pour plus de familles partout au pays. Depuis le début de la pandémie, les banques alimentaires ont enregistré une hausse de plus de 50 % du nombre de personnes ayant besoin de leurs services. Si la tendance actuelle se maintient, les banques alimentaires de Toronto enregistreront 1,4 million de visites d’ici la fin de 2021. 

Pendant plusieurs années, la Fondation CC&L a donné à la Daily Bread Food Bank de Toronto et a récemment accru son soutien en s’engageant à apporter son aide sur plusieurs années. Fondée en 1983, Daily Bread est devenue l’une des plus importantes banques alimentaires au Canada. Elle vise à ce que personne ne souffre de la faim ou se heurte à des obstacles pour accéder à de la nourriture. Elle offre des repas sains et nutritifs aux personnes qui vivent dans l’insécurité alimentaire au moyen de presque 200 programmes alimentaires.

« Bien qu’un sentiment de normalité revienne dans notre ville, la réalité est très différente pour des dizaines de milliers de personnes vivant dans la pauvreté. En août 2021, plus de 113 000 personnes se sont présentées aux banques alimentaires membres de Daily Bread, soit une hausse de 67 % par rapport à la même période l’an dernier », affirme Neil Hetherington, chef de la direction de Daily Bread Food Bank. « Nous sommes profondément reconnaissants envers CC&L d’avoir accepté, à l’occasion de l’Action de grâces, de verser un don généreux qui garantira que toutes les personnes, adultes, aînés ou enfants, de notre ville qui vivent dans l’insécurité alimentaire pourront se procurer des aliments. »

À propos de la Fondation Connor, Clark & Lunn

Créée en 1999, la Fondation CC&L est soutenue par le Groupe financier CC&L et ses sociétés affiliées, et reçoit des demandes de ses clients, de ses employés et d’autres personnes en vue de financer des programmes et des organismes sans but lucratif voués à la promotion d’un meilleur environnement, à l’amélioration de l’éducation, à l’avancement des sciences et de la médecine, au développement de collectivités plus dynamiques et aux arts.

Personne-ressource

Colin Aubrey
Directeur général
Fondation Connor, Clark & Lunn
[email protected]

The global manufacturing PMI new orders index – a timely indicator of industrial momentum – registered a surprise small rise in September, with weaker results for major developed economies foreshadowed in earlier flash surveys offset by recoveries in China and a number of other emerging markets.

Does this signify an end to the recent slowdown phase, evidenced by a fall in PMI new orders between May and August? The assessment here is that the rise should be discounted for several reasons.

First, it was minor relative to the August drop. The September reading was below the range over October 2020-July 2021.

Secondly, the increase appears to have been driven by inventory rebuilding. The new orders / finished goods inventories differential, which sometimes leads new orders, fell again – see chart 1.

Chart 1

Remember that orders growth is related to the second derivative of inventories (i.e. the rate of change of the rate of change). Inventories are still low and will be rebuilt further but the pace of increase – and growth impact – may already have peaked.

Thirdly, the recovery in the Chinese component of the global index was contradicted by a further fall in new orders in the official (i.e. NBS) manufacturing survey, which has a larger sample size. The latter orders series has led the global index since the GFC – chart 2.

Chart 2

Fourthly, the OECD’s composite leading indicators for China and the G7 appear to have rolled over and turning points usually mark the start of multi-month trends. The series in chart 3 have been calculated independently using the OECD’s published methodology and incorporate September estimates (the OECD is scheduled to release September data on 12 October). The falls in the indicators imply below-trend and slowing economic growth.

Chart 3

Finally, additional August monetary data confirm the earlier estimate here that G7 plus E7 six-month real narrow money growth was unchanged at July’s 22-month low – chart 4. The historical leading relationship with PMI new orders is inconsistent with the latter having reached a bottom in September. The message, instead, is that a further PMI slide is likely into early 2022, with no signal yet of a subsequent recovery.

Chart 4

While the focus of inflation is typically centered on rising raw material costs and wage increases, we are seeing transportation costs become an additional and significant part of the inflation problem, and one that is not as easily passed on to consumers.

Transportation affects every aspect of a company’s supply chain and the rising costs are unavoidable. Further, it has been a recent topic of conversation for our own holdings, as well as some of the largest companies in the world. At a recent conference, Molson Coors, the fifth largest brewer in the world, said transportation costs are the main contributing factor to inflation, while Proctor and Gamble warned that an announced price increase will not be enough to offset higher commodity and transportation costs due to not only the size, but the speed of the increases. Multinational conglomerate 3M is a good barometer, as it is seeing “a lot of pressure on logistics costs.” Dollar Tree is one of the largest retail importers in the United States (US) and at their recent quarterly earnings presentation, they spent a considerable amount of time discussing the global supply chain and higher freight costs, saying they were “not counting on material improvements in 2022, especially in the first portion of the year.”

The recovery from the pandemic has seen a huge increase in demand, but with continued quarantine controls, distancing measures at ports and labour shortages are causing severe backlogs. The Suez Canal blockage and summer typhoons off the Chinese coast did little to ease the problem. Another consideration is the consolidation of ocean shipping lines’ key shipping routes being dominated by a handful of companies, causing fewer vessels in general to be travelling between ports.

The ocean carriers have responded to the high demand by increasing container capacity by 22%, but this does not solve the problem of logjams and the waiting lines reaching record levels at some of the ports.[1] The order book for container ships has doubled in 2021, but the majority won’t be delivered until 2023.

So what does all this mean? Container rates seem to be stabilizing, yet remain extremely elevated. Freightos, a digital booking platform for international shipping, published containerized freight rates. The cost of a container from Asia to the US East Coast is over $20,000, an increase of 415% compared to last year. Shipping from Asia to the US West Coast is slightly less, but the cost is up 452% in comparison to a year ago. Shipping from Asia to North Europe has seen the largest year-over-year increase, up 714% to $13,855. Freight rates from Northern Europe to the US East Coast have been the least affected, up “only” 238% from the period last year to $5,929. In view of these rates, shipping companies are focusing on the most profitable trade routes, meaning reduced volumes crossing the Atlantic. The Baltic Dry Index is a benchmark for the price of shipping major raw materials by sea and is at its highest level since before the Great Financial Crisis.

Source: Bloomberg

The majority of companies are struggling to solve this logistical headache, but our portfolios contain two names that have been natural beneficiaries.

Clipper Logistics (CLG.LN) is a leading provider of value-added logistics solutions, e-fulfilment, and returns management services to the retail sector, primarily in the United Kingdom (UK), but with an expanding presence in Europe. Sales are comprised of the following: 60% of sales come from e-fulfilment and returns management, supporting the online activities of customers; 28% of sales come from non e-fulfilment businesses, supporting traditional brick and mortar customers; and the remaining 12% of sales comes from commercial vehicles sales. Of the logistics related revenues, 85% comes from the UK. Over 90% of Clipper’s contracts are on an open book basis (i.e. cost plus), or hybrid contract, protecting them from increasing costs. However, they are not immune to labour shortages, as they recently flagged the impact that a shortage of HGV drivers is having.

Kerry Logistics (636.HK) is a third-party logistics service provider based in Hong Kong with global exposure. The company provides many supply chain solutions, including integrated logistics, international freight forwarding (air, ocean, road, rail, and multimodal), industrial project logistics, cross-border e-commerce, last-mile fulfilment, and infrastructure investment. Revenue mainly comes from Asia-Pacific, which accounts for 74% of sales (Mainland China 32%, Hong Kong 13%, Taiwan 7%, and other Asia 21%). The Americas accounts for 16% and Europe about 10%. Their customers are mainly big multinational companies, across many industries, including fashion, electronics, food and beverages, FMCG, industrial, automotive, and pharmaceutical.

Perhaps the best advice we could give readers is that with supply chain and transportation issues showing little signs of abating, you would be wise to start your holiday shopping sooner, rather than later.

[1] https://splash247.com/more-than-40-ships-waiting-outside-la-and-long-beach-setting-new-record/

US Treasury yields have risen sharply since Fed Chair Powell’s signal last week of a likely tapering decision at the November or December FOMC meeting. The move higher mainly reflects an increase in real yields, with inflation break-evens range-bound – see chart 1.

Chart 1

The reaction recalls a surge in nominal and real yields when former Chair Bernanke signalled that the Fed was considering tapering in Congressional testimony on 21 May 2013. Inflation breakevens, which had been falling into the announcement, declined further before recovering – chart 2.

Chart 2

Bernanke’s signal was a catalyst for real yields – which had reached negative levels similar to recently – to return to positive territory. The yield surge triggered a short-lived “risk-off” move in markets, focused on emerging markets and credit (the “taper tantrum”).

The market response spooked the Fed, causing the taper decision to be delayed until December 2013. When tapering finally started in January 2014, nominal and real yields embarked on a sustained decline. Inflation breakevens moved sideways but also fell later in 2014.

Cyclical sectors of equity markets outperformed defensive sectors between Bernanke’s May announcement and the start of tapering in January.

The view here, though, is that investors should be cautious about drawing parallels between 2013-14 and now.

The economic backdrop is a key difference. The global manufacturing PMI new orders index was about to embark on a significant rise as Bernanke gave his taper signal in May 2013 – chart 3. So it is difficult to disentangle the taper effect on yields from the usual correlation with cyclical momentum.

Chart 3

Economic momentum is slowing currently, with money trends suggesting a further PMI decline into early 2022.

This suggests that 1) the yield increase won’t mirror 2013 because the taper announcement effect is offset by a weakening cyclical backdrop, and 2) any rise in real yields could be dangerous for cyclical assets because – in contrast to 2013 – a higher discount rate is unlikely to be balanced by positive economic / earnings news.

In this special commentary, we discuss the evolving Evergrande situation. While we do not hold Evergrande in our portfolio, we wanted to share our views because it is the most indebted real estate company in the world, and has created lots of volatility in the global financial market.

Background on Evergrande

Evergrande is the second largest property developer in China in terms of sales value. The company has 160,000 employees and close to 4 million employees related to Evergrande’s activities. It has a total debt of RMB 2 trillion (around USD $300 billion, equivalent to 1% of deposits in China, and almost 2% of China’s GDP), including interest-bearing debts of RMB 571 billion, pre-sale of RMB 216 billion, payables of RMB 963 billion, and wealth management products of RMB 100 billion. It is one of the most levered real estate companies in the world, but its debt is still minor in relation to China’s financial system as a whole. Considering the above data, we believe China’s financial system can absorb, without any mayor problem, all the losses from this company.

Potential of creating a contagion effect on the broader global financial markets?

This is not another Lehman. We think the contagion effect on the broader global financial markets is limited. The Evergrande saga remains a domestic issue. The Chinese government has enough capacity to intervene and will do so to reduce the contagion risk.

The recent news is an example: Evergrande reached an agreement with yuan bondholders on an interest payment due September 23, 2021, without clarifying the terms. The Chinese government injected RMB 120 billion into the banking system on September 22, 2021.

The major risk is a contagion to other developers, banks, suppliers, holders of Evergrande’s wealth management products, and home buyers. A possible scenario is that the government could take over the problem companies with state-owned enterprises (SOE).

As the property policy is unprecedentedly tight at this moment, the government has plenty of room to loosen if they want. It is likely that they are willing to wait in order to show that the real estate sector is not “immune” but that they can come in at any time in order to preserve financial stability. Many loans to Evergrande made by Chinese banks are implicitly backed by the government. We believe that the first priority for the government is to ensure that the pre-sold apartments are delivered to the buyers, otherwise, there will be serious social unrest.

Regulatory headwinds coming from China

The key words for China’s policy is currently “Common Prosperity,” which fundamentally entitles a policy shift towards reducing wealth inequality. The concept is not new; it has been a long-term goal of the Chinese government that has become more relevant recently.

The Central Party and State Council jointly announced the plan on June 10, 2021, establishing Zhejiang province as the pilot zone. The 14th five-year plan (2021-2025) called for an “action plan” to be fully implemented by 2050, to become an advanced, modern economy. Among common prosperity goals are narrowing the income gap, tackling the increasing real estate prices, promoting higher household income growth, increasing public services, such as healthcare and education, and improving living conditions of rural residents, among many others. These common prosperity initiatives will likely rebalance the economy from investments to consumption, targeting the midlow-income population. Moreover, the state’s role in public and private sectors is likely to become more relevant.

In the upcoming Politburo meeting this December, policymakers will set priorities for next year.

Appendix

Examples of contagion risks:

  1. Other developers will find financing more difficult, if investors lose confidence in them. Project sales will also become more difficult. As a matter of fact, the selling prices of properties are controlled by the governments, so developers are not able to sell their properties at discounts.
  2. Suppliers should be more cautious on payment terms and conditions on other developers. They would also see lower demand and production. Some may need to cut jobs or wages, causing weaker household consumption.
  3. Home buyers (more than a million) are also heavily protesting at Evergrande’s offices causing their construction projects to be halted. Home buyers that are working with other developers may also doubt their houses would be delivered, therefore, causing more selling pressure.
  4. Local governments receive transfers from the central government with bond issues via Local Government Financing Vehicle (LGFV) which are collateralized with land use rights. Raising funds for local governments could eventually become more complicated.
  5. More default scenarios of individual companies are also likely to occur. For example, Sinic (2103 HK) was implied to have financial problems, and the stock slumped 87% on September 20, 2021.

Chinese government successfully resolved the interbank credit crunch in 2013. Tools that the
government could use this time:

  • Easing liquidity: RRR cut, liquidity injection
  • Verbal support
  • Controls of LGFV financing likely to become less tight
  • Loosening of property policy
  • Accelerating LG bonds
  • Maintaining low rates
  • Persuading banks to lend

The systemic risk is not high.

  • Although Evergrande has a larger balance sheet (RMB 2.4 trillion) than Huarong (RMB 1.6 trillion) and Anbang (RMB 1.5 trillion), its asset contains largely land lots which are much more “tangible than the other financial companies.”
  • Since the government controls the financial system, many SOEs could be strategic investors of Evergrande and also adjust the property policies.
  • When the People’s Bank of China (PBoC) initiated its support to the property sector (printing money) in-mid 2014, it granted a long term loan to China development bank. PBoC said at that time, “A change emerged in the base money supply channel.”
  • The government could buy their own land, as they did in 2014-2015.
  • In the case of Evergrande, the government can let them fall, avoiding a contagion or make an orderly debt restructuring. In similar cases they have taken actions. In the case of Anbang, several SOEs took up the company and formed a new insurance company. In the case of Huarong, Citic Group (a SOE) and other “strategic” investors capitalized the company.

Thoughts on the stock market

It is worth noting that the Chinese government seems to have downplayed the importance of paying too much attention to short-term growth. They indeed have a short-term buffer, considering the 2021 GDP target is “above 6%,” and the country is likely to grow in the range of 8% this year. The current outlook is more focused on solving structural problems, which may have short-term collateral consequences, but the vision is to improve the long-term perspective. Indeed, President Xi has emphasized on numerous occasions that the aforementioned long-term goals are not just an economic objective, but serve as the Party’s “governing foundation”. The foregoing is still interesting, since, as previously mentioned, the Western vision is often different. Billions of dollars have been lost in market capitalization of the Chinese assets sector, driven by strict regulatory policy in the afterschool tutoring, together with anti-monopoly and cybersecurity rules in the internet sector. The government has also tightened property policies. Currently, a blanket of uncertainty persists regarding « which sector will be regulated next. » For example, almost one month ago, a state media article equated the gaming industry, which has many companies that trade on the stock market, to “opium”. Although the government quickly quashed this article and there were no official statements, it caused a rapid slump of shares linked to the gaming sector, reflecting the prevailing nervousness among investors. The government recently released new regulations for the industry, including limiting the amount of time children can play video games to three hours a week, and last week state media mentioned that companies should avoid the sole focus of pursuing profit, in order to prevent minors from becoming addicted to games. This sentiment led to another round of losses in gaming-related stocks.

We believe China is trying to improve its society in the long term, but are not very concerned about the effect this may have on investors in the short term. The question then is; how can we better cope and adjust to these policies for the benefit of our clients? China accounts for around 10% of the MSCI EM Small Caps index, making it an important investment for our EM Small Cap fund. Our approach to this new environment is to understand the domestic perspective and invest in companies/sectors that are subject to less regulation and more likely to benefit from the new trends that we see emerging in the future. Each scenario presents a new opportunity and the trends include:

  • Greater self-reliance on government-fostered technology (semiconductors, artificial intelligence);
  • Renewable energy;
  • Fitness;
  • Consumption favouring local brands/companies; and
  • Manufacturing industry and robotics for products designed mainly to support and strengthen the Chinese economy.

The global pandemic has caused a sharp, worldwide economic contraction, with supply and demand severely affected across many industries. However, the real estate market was one of the few to experience strong and sustained growth in 2020 and 2021. House prices rose consistently, driven by robust demand and constrained supply.

On the demand side, buyer interest has surged since summer 2020, as people are scrambling to take advantage of low mortgage rates due to fear of missing out. According to the Mortgage Bankers Association (MBA), in the United States (US), the value of mortgage originations for new purchases increased by 13% in 2020, in comparison to 2019, despite the fact that most economic activities were effectively halted in April and May 2020. As America’s biggest generation, millennials have entered their prime years of purchasing power, driving the demand for houses even further. On top of that, as people spend more time at home during the pandemic, demand for bigger spaces increased significantly.

On the other hand, supply has been extremely tight. In the US, months of supply in July 2021 was 2.6, which is an increase from the record low of 1.9 in January 2021, but still at a historically low level. Historically, a balanced market has been defined as 6.0 months of supply. Even before the pandemic, there was a shortage of homes for sale. From 2010 to 2019, the US had the lowest number of homes built than any other decade since the 1960s.[1] From 2010 to 2019, only 5.8 million homes were built, compared to over 27 million homes built from 2000 to 2009. Strong demand for housing in recent years, fueled by low mortgage rates, has exaggerated the imbalance of supply and demand. As a result, house prices keep going up.

The strong residential market is not limited to the US. In the United Kingdom (UK), house prices have been increasing consistently since May 2020. In June 2021, the average house price was £266,000, up 13.2% year over year and 4.5% month over month. This is partially due to the stamp duty holiday introduced in July 2020 to help homebuyers and boost the UK property market during the pandemic. Even though the stamp duty holiday will gradually taper from July 2021, demand still outstrips supply, and prices are expected to stay on the upward trend. One of our holding companies, Savills (SVS LN), has been benefiting from this trend. Founded in 1855, Savills is one of the world’s leading property service providers for both residential and commercial properties. They have a dominant position in many markets across the globe, with more than 600 offices across the Americas, Europe, Asia Pacific, Africa, and the Middle East. In the first six months of 2021, Savills hit record profits thanks to the hot UK housing market, with revenue in the country having increased by 40% year over year.

This housing boom has been positive news for homeowners; CoreLogic analysis shows homeowners with mortgages (roughly 62% of all properties) in the US have seen their equity increase by a total of $1.9 trillion  since the first quarter of 2020, an increase of 19.6% year over year. However, it has also reduced housing affordability, and shut a growing number of people out of the housing market. In the US, homeownership has been falling after its previous peak of 69% in 2004.[2] In the second quarter of 2021, homeownership dropped to 65.4%, which is 2.5 percentage points lower than in Q2 2020. The rate varies significantly by race, with the biggest gap observed between non-Hispanic white households and Black households, homeownership rates for which were 74.2% and 44.6%, respectively. If the trend continues, the US homeownership rate will decline to 62% by 2040.

Therefore, it is crucial to increase the supply of affordable homes to meet the needs of future homeowners and renters. Century Communities (CCS US), a top ten national homebuilder and a holding company in our portfolios, focuses on affordable homes. Entry-level buyers represent 80% of their total deliveries. A total of 43% of the homes are under the price of US $250,000, and close to 90% of homes are under the price of US $500,000. In the second quarter of 2021, the company’s home sales revenue increased by 34% to a record $1 billion, and net income increased by 207% to a record $117.9 million. The company has increased their revenue guidance for 2021, and remains confident in its success in the second half of the year.

It’s not just the home buyers, renters also faced a significant amount of financial stress. In the first quarter of 2021, 17% of all renter households in the US reported being behind on rent. This rate is 21% for Hispanic and 29% for Black renters. Several companies in our portfolio contribute to the rental market’s affordability.

Boardwalk Real Estate Investment Trust (BEI-U CN) is one of Canada’s largest multi-residential real estate owners and managers. Founded in 1984, the company owns 33,513 residential suits, concentrated in Alberta, Quebec, Saskatchewan, and Ontario. The REIT is committed to providing the best product quality and experience to their clients, at affordable prices. The average rent is approximately 20% of the average renter’s household income. Thanks to its strong brand of service at affordable prices, Boardwalk has been gaining market share, and maintained an above-market-average occupancy rate.

SBB (SBBB SS) is a Swedish-focused, social infrastructure property company. Of its portfolio, 94% is in rented residential and social infrastructure, including education, senior care, healthcare, and government/municipal buildings. The government backs 88% of the rent. As of Q2 2021, the company invests 27% of its social assets in affordable housing. The average rent levels for SBB’s rent-regulated residential portfolio is about 40% below the rent levels of new productions.

Advance Residence (3269 JP) is the largest residential REIT in Japan. They focus on compact apartments, mainly in Tokyo metropolitan areas; 64% of its portfolio are studio and one-bedroom properties, the rents for which are more affordable. Over 50% of the rents were below JPY 100,000 per month (approximately US $911). As a comparison, a typical mid-range, two-bedroom apartment in Tokyo is about US $1903 per month, according to a Deutsche Bank report.

Affordable housing is part of Goal 11 of the Sustainable Development Goals (SDGs). It’s also central to achieving almost all of the SDGs. The demand for affordable housing keeps growing, given the trend of urbanization and population growth. Investment in this theme will not only allow us to ride the secular trend, but also contribute to a more sustainable and inclusive future.  

[1] https://www.statista.com/statistics/1041889/construction-year-homes-usa/

[2] As defined by the US Census Bureau, the homeownership rate is the proportion of households that is owner-occupied.

The global industrial slowdown signalled by a fall in manufacturing PMI new orders over June-August is now being reflected in a loss of earnings momentum.

The MSCI All Country World Index (ACWI) weekly revisions ratio, seasonally adjusted, fell below zero last week to its lowest level for more than a year – see chart 1.

Chart 1

With global real narrow money trends suggesting a further decline in manufacturing PMI new orders through early 2022, the revisions ratio is likely to remain in negative territory for the foreseeable future.

A falling PMI / weakening earnings momentum is typically associated with underperformance of non-tech cyclical equity market sectors (i.e. materials, industrials, consumer discretionary, financials and real estate) versus defensive sectors (consumer staples, health care, utilities and energy). The MSCI ACWI non-tech cyclical / defensive sector price relative has moved down in recent days, though remains above an August low – chart 2.

Chart 2

The latest decline, of course, reflects macro risk aversion due to the Evergrande crisis. The MSCI Emerging Markets non-tech cyclical / defensive sector price relative has crashed to a new low, with more modest weakness in the corresponding MSCI World (i.e. developed markets) relative – chart 3.

Chart 3

As the chart shows, the EM relative led moves down into lows in 2011-12, 2016 and 2018 (all associated with stockbuilding cycle downswings). The current wide divergence raises the possibility of a breakdown of the MSCI World relative; alternatively, the EM relative may have greater recovery potential.

Street research is discussing whether a looming Evergrande default represents a Minsky / Lehman moment (i.e. a tipping point into a financial crisis) or a Volcker moment (i.e. a policy decision to punish inflationary / speculative excess despite harsh macroeconomic consequences). The consensus is neither and that the authorities will be able and willing to contain the fallout.

The key issue, from a monetarist perspective, is whether tighter financial conditions due to the crisis persist and invalidate the previous central case scenario of a recovery in monetary trends in response to recent and prospective policy easing. Six-month growth rates of the private sector money measures calculated here fell back in August but remain above May lows – chart 4.

Chart 4

A useful indicator for assessing the potential monetary fallout is the corporate financing index from the Cheung Kong Graduate School of Business survey of private sector firms, a gauge of ease of access to credit. The index loosely correlates with money growth and has moved sideways (after seasonal adjustment) in recent months – chart 5. A sharp fall in the upcoming September survey would be a clear warning signal.

Chart 5

An FTarticle lists “Five big questions facing the Bank of England over rising inflation”. The most important one is missing: will broad money growth return to its pre-covid pace?

The current inflation increase, from a “monetarist” perspective, is directly linked to a surge in the broad money stock starting in spring 2020. Annual growth of non-financial M4 – the preferred aggregate here, comprising money holdings of households and private non-financial corporations (PNFCs) – rose from 3.9% in February 2020 to a peak of 16.1% a year later.

The monetarist rule of thumb is that money growth leads inflation with a long and variable lag averaging about two years. This is supported by research on UK post-war data previously reported here – turning points in broad money growth preceded turning points in core inflation by 27 months on average.

The lead time is variable partly because of the influence of exchange rate variations. For example, the disinflationary impact of UK monetary weakness after the GFC was delayed by upward pressure on import prices due to sterling depreciation.

The exchange rate has been relatively stable recently but the rise in inflation has been magnified by pandemic effects, which may mean that a peak occurs earlier than suggested by the February 2021 high in money growth and the average 27 month lag. The working assumption here is that core inflation will peak during H1 2022.

CPI inflation, however, is likely to overshoot the current Bank of England forecast throughout 2022 – chart 1 shows illustrative projections for headline and core rates.

Chart 1

The past mistakes of monetary policy are baked in. The MPC should focus on current monetary trends in assessing how to respond to its current / prospective inflation headache.

Annual broad money growth has fallen steadily from the February peak but, at 9.0% in July, remains well above the 4.2% average over 2010-19, a period during which CPI inflation averaged 2.2%. So monetary data have yet to support the MPC’s assertion that the inflation overshoot is “transitory”.

The pace of increase, however, slowed to 4.4% at an annualised rate in the three months to July – chart 2. Household M4 rose by 5.8% with PNFC holdings little changed. In terms of the credit counterparts, bank lending to households and PNFCs grew modestly (4.1%) while a continued QE boost was offset by negative external flows, suggesting balance of payments weakness.

Chart 2

With QE scheduled to finish at end-2021 (if not before), and a temporary boost to mortgage lending from the stamp duty holiday over, money growth couldbe gravitating back to its pre-covid pace.

An early interest rate rise, on the view here, is advisable to reinforce the recent monetary slowdown and push back against rising inflation expectations. It is premature, however, to argue that a sustained and significant increase in rates will be needed to return inflation to target beyond 2022 – further monetary evidence is required.

It would be unfortunate if, having fuelled the current inflation rise by questionable policy easing, the MPC were now to raise expectations of multiple rate hikes at a time when monetary growth could be returning to a target-consistent level.