GBP Currency devaluation and its effect on inflation

Gilts, bonds, and interest-bearing shares
air04
Posts: 3
Joined: November 10th, 2016, 11:19 am

GBP Currency devaluation and its effect on inflation

Postby air04 » November 15th, 2016, 12:11 pm

I am invested in a lot of inflation corporate linked bonds(http://www.fixedincomeinvestor.co.uk/x/bondtable.html?groupid=3562)

With GBP falling around 20%, what is the estimated effect on inflation in total due to the currency devaluation. A lot of price will not change by 20%, as there are a lot of costs(and taxes) specific to the UK and not imported inflation.

The four inflation linked bonds have appreciated by around 10%. Will a 20% fall in pound really affect inflation by 10%, or is it the usual swing to extremes?
[url]http://uk.advfn.com/p.php?pid=legacydaily&epic=L^TS1L&type=1&size=2&period=7&olx_1=1&o_epic1=L^PFP1&o_type1=1&o_colour1=1&olx_2=1&o_epic2=L^SVTL&o_type2=1&o_colour2=2&olx_3=1&o_epic3=L^NG1Q&o_type3=1&o_colour3=3&scheme=&delay_indices=1[/url]

I realise that it may be quite complicated to come up with a figure, but I was looking at a rough estimate. The BOE speaks of 2%/3% inflation, does it really mean that 20% currency drop causes only 1-2% inflation(the other 1% was there before too)?

I think I am missing something obvious.

Thanks in advance,
ap

gryffron
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Re: GBP Currency devaluation and its effect on inflation

Postby gryffron » November 15th, 2016, 9:22 pm

Well according to this http://data.worldbank.org/indicator/NE.IMP.GNFS.ZS... U.K. Imports are 30% of GDP. I'd have thought it would be more useful as a % of spend, but there you go. So all else being equal (which of course it isn't) I'd expect a 20% rise in import costs to give a (additional) 6% rise in inflation. Eventually, probably over a couple of years.

Gryff

Chloe
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Joined: November 4th, 2016, 11:00 am

Re: GBP Currency devaluation and its effect on inflation

Postby Chloe » November 16th, 2016, 7:49 am

Only about an hour later than your post, an eminence from a think tank on the Daily Politics suggested that the depreciation would result in an extra 2.5% inflation, probably spread over about 3 years.
If you want to see more accurately for yourself, it was at 12 mins xx secs into http://www.bbc.co.uk/iplayer/episode/b0 ... s-15112016

CB

Wizard
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Re: GBP Currency devaluation and its effect on inflation

Postby Wizard » November 17th, 2016, 9:16 am

I heard discussion of the recent inflation figures on R4 a day or so ago. One analyst was commenting that the UK retail sector is so competitive that retails are desperately trying to find ways to avoid passing on cost increases to the ultimate customer. Cost reduction programmes are ongoing.

I contrast that to the almost immediate and dramatic increases in prices I observed in woodworking machinery (I make furniture as a hobby), within days of the referendum prices from almost all retailers were up, many be as much as 20%. These are all small companies with no ability to squeeze suppliers and the vast majority of woodworking machinery is imported from China these days.

So in conclusion I think it is more complicated than just extrapolating from the movement in the pound, there are other factors at play.

Terry.

clissold345
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Joined: November 14th, 2016, 11:05 am

Re: GBP Currency devaluation and its effect on inflation

Postby clissold345 » November 19th, 2016, 12:02 pm

Anyone who is interested can download the latest inflation Report from the Bank of England's website. There may be some interesting info in it. I noticed this quote, which tallies in part with what Terry/Wizard wrote.

"The precise path for inflation will depend on the speed and
degree to which companies pass through rising external costs
(Section 4.2) to consumer prices, given domestic conditions
(Section 4.3). Subdued domestic demand growth (Section 2)
is likely to weigh somewhat on companies’ margins and wage
growth, and offset slightly the upward pressure from external
costs on inflation. The influence of domestic pressure on
inflation will also depend on companies’ and households’
inflation expectations, insofar as they influence wage and
price-setting behaviour (Section 4.4)."

I also noticed this quote about how fast the rise in import costs might feed through:

"The rise in import costs — which represent close to a third of
the CPI basket — is expected to be passed through fully to
consumer prices over several years. For some items, such as
food, changes in import costs tend to feed through quickly to
consumer prices. For other items, pass-through is more drawn
out. Given the size of the fall in sterling, and its association
with a weaker outlook for supply, the MPC judges that
pass-through to CPI inflation will be a little quicker than
usually assumed, in line with evidence from previous episodes
(Section 4)."

1nv35t
Lemon Slice
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Re: GBP Currency devaluation and its effect on inflation

Postby 1nv35t » November 28th, 2016, 4:23 pm

Inflation is currently being driven by imports and the weaker pound following Brexit fears. 2017 could very well see greater concerns with the US$ and Euro ... a stronger pound and a return to deflation concerns, maybe with the BoE even performing additional QE to calm a strengthening pound

The UK's debt is sound. Large, but around 25% of it is held by the BoE who return all interest payments received back to the Treasury. Older higher cost (yield) Gilts. Newer gilts were issued at relatively low yields spread out over many decades. The UK's history is such that we can borrow for relatively low rates, for long periods of time. Many others have far shorter duration before debts have to be rolled (subject to the yields at that time) or repaid.

Compared to many alternatives the UK is geopolitically safe with sound financial structure, albeit that the deficit (spending) is out of kilter with revenues. Modest growth could realign that deficit (higher tax revenues). Brexit uncertainties are keeping the economy more suppressed and with greater clarity it will do OK. A modest degree of inflation for a while together with a relatively lower pound actually help things - so much so that its as though the government were trying to induce such (spread fear, talk the Pound down etc.) :)

1nv35t
Lemon Slice
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Joined: November 4th, 2016, 8:18 pm

Re: GBP Currency devaluation and its effect on inflation

Postby 1nv35t » November 28th, 2016, 4:30 pm

Worthy of note is that the IMF still have the Pound as a fair chunk of SDR's ... around 8% (similar to Japanese Yen) since having added in China's renminbi (11%). US and Euro make up the rest (around 42% and 31% respectively). Being part of the 'reserve currency' serves as a support.

Generali
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Re: GBP Currency devaluation and its effect on inflation

Postby Generali » December 3rd, 2016, 8:16 am

gryffron wrote:Well according to this http://data.worldbank.org/indicator/NE.IMP.GNFS.ZS... U.K. Imports are 30% of GDP. I'd have thought it would be more useful as a % of spend, but there you go. So all else being equal (which of course it isn't) I'd expect a 20% rise in import costs to give a (additional) 6% rise in inflation. Eventually, probably over a couple of years.

Gryff


That's the first order effect although I'd imagine that some of the cost increase will be absorbed by companies taking lower profits rather than passing on the full increase. Also the impact will be mitigated to some extent by import substitution (people drinking British beer rather than French wine).

Then there is likely to be a second order effect where domestic companies that are competing with imports see an opportunity to increase prices while maintaining market share (British beer makers put up their prices a bit and still manage to compete against French wine).

Then there's a third order effect where domestic workers are fed up that their standard of living has fallen as a result of all these price increases and so demand a pay rise. With unemployment at 5% and Brexit presumably cutting the supply of immigrant labour at some point it is likely that many will get pay rises. Employers will be forced to put up prices in order to pay the higher salaries, reduce profits or cut the number of workers they employ so that either leads to still higher prices or increased unemployment, most likely a combination of the three.

If the GBP stays 20% lower in two years time I'd be completely unsurprised to see prices 8-10% higher than today on average (inflation rate 4-5%). There's a small chance, again if the pound stays at the new lower level, that things get a bit out of hand with inflation hitting 10% in a couple of years although I really don't think that's likely.

ap8889
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Re: GBP Currency devaluation and its effect on inflation

Postby ap8889 » December 3rd, 2016, 8:47 am

Price of oil is a key unknown as commodity input price will feed through as inflation.

At present many are expecting POO to rise in dollar terms which means a big rise in devalued pound terms. However markets are often wrong and a low POO will tamp down inflation.


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