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5 "Tells" that the Stock Markets Are About to Reverse

UK CPI Inflation +2.4%, RPI Deflation -1.2% Hits Forecast Target

Economics / Deflation May 20, 2009 - 01:05 AM GMT

By: Nadeem_Walayat

Economics

Best Financial Markets Analysis ArticleUK RPI Inflation data of minus 1.2% for April 09 represents severe deflation in the official data. Whilst the Governments preferred CPI inflation measure has recorded a smaller decline to 2.3% which still stubbornly puts it above the Bank of England's target rate of 2%. RPI deflation is not surprising given the panic interest rate cuts from 5% at the beginning of October 2008 to just 0.5% by the last cut of March 2009, these cuts in interest rates coupled with quantitative easing aka "money printing" to drive down long-term interest rates and hence mortgage rates is resulting in real deflation for those with large mortgages of as much as minus 5%, therefore this is providing for mini 'temporary' cash flow boom for those mortgage holders that have secure employment during the recession and therefore contributing to the summer bounce in house prices.


However the temporary bounce in house prices needs to be set against the bursting of the asset bubble that has seen UK house prices fall by 21% from the peak of August 2007. UK deflation in the face of the bursting of the asset bubble has now hit the inflation target of -1.2% and therefore expected to reverse trend on the RPI measure over the summer months with signs that the preferred measure of CPI is already warning of gathering inflationary clouds as the gap between RPI and CPI Inflation continues to widen to new extremes.

The trend in inflation data remains inline with my original forecast as of Dec 08 that forecast deflation into mid 2009, followed by a slowly rising inflationary trend during the second half of 2009. RPI of -1.2% will also have the effect of depressing wages as this measure is used to determine pay deals therefore continuing deflation throughout 2009 despite money printing which suggests some overshoot on RPI to the downside.

UK Money Supply - Deflation

Whilst UK Money supply M4 (blue) has risen sharply from the 10% targeted low of mid 2008 to the current level of 17.7%, on face value this is highly inflationary and has been taken by some economists and market commentators to suggest much higher forward inflation. However the money supply adjusted for the velocity of money which takes into account the state of the economy as a consequence of the credit freeze tells a completely different story. The UK economy is now in extreme real monetary deflation of approaching -30%. The leading indicator of the implied money supply, is suggesting recent deep interest rate cuts to just 0.5% have so far failed to lift future money supply growth out of extreme deflation which therefore continues to suggest deflation for all of 2009, and hence implies inflation could overshoot to the downside against the forecast trend mentioned earlier.

Budget Deficit and Quantitative Easing

The Bank of England has already printed £125 billion of money so as to buy mainly government bonds in response to the huge budget deficit that the Labour government will rack up by the end of this year that projects to £175 billion which is up from £38 billion in November. The outlook for subsequent years also remains for bleak with deficits expected to continue for many years as Alistair Darlings own forecast for government net borrowing over the next 4 years has grown from a deficit of £120 billion in November 2008 to £608 billion as of the budget, which is still significantly below my forecast total of £735 billion and therefore the expectation remains for further revisions to the upside over the coming years. This confirms my view that the Bank of England will continue printing money into year end to beyond the £150 billion current arrangement. Which on face value is both inflationary and supportive of the economy.

UK Recession Forecast

Total GDP contraction to date now stands at -4% on a quarter on quarter basis, which is against my forecast for -6.3% total into Q3 2009, which strongly suggests that GDP contraction during the 2nd and 3rd quarters for 2009 'should' now moderate i.e. we are unlikely to see another figure as bad as 1st Q -1.9%, more probably the 2nd quarter GDP is likely to be at -1%. Whilst a bounce back in the economy is expected going into the 2010 election, however the tax hikes and spending cuts will in all likelihood trigger a double dip recession during 2011 to 2012 as illustrated by the above graph. What this means is that there will continue to be a major shortfall in tax revenues and therefore continuing budget deficits and hence deeper public spending cuts and therefore continuing downward pressure on prices and hence inflation may remain subdued even beyond 2010 after a temporary rise inline with the bounce in GDP.

UK Inflation Conclusion - Extreme Deflation as measured by RPI is near an imminent end, forward inflation will remain subdued despite economic recovery into the 2010, election as the risks of a double dip recession remain which would be accompanied by lower inflation.

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By Nadeem Walayat
http://www.marketoracle.co.uk

Copyright © 2005-09 Marketoracle.co.uk (Market Oracle Ltd). All rights reserved.

Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analysing the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem's forward looking analysis specialises on the housing market and interest rates. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 250 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

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Comments

mandy
08 Sep 10, 15:17
inflation

Thanks for clarity of vision


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