King for a Few More Days

THE WEEK: Morningstar columnist Rodney Hobson discusses Sir Mervyn King's latest inflation expectations and Europe's economic progress (or lack thereof)

Rodney Hobson 15 February, 2013 | 11:17AM
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A few economic truths hit home this week, none of them pleasant. Yet the stock market has held up remarkably well at levels last seen in 2008 when the dam burst. The nascent bear rally of 2013 remains intact despite everything.

King has been pretty blunt for the occupant of a post that tries not to take political sides

One truth I never thought I would hear was the admission by the outgoing Bank of England governor Sir Mervyn King that inflation will persist above the 2% central target. King actually suggested a three year time span in sharp contrast to the rapid decline he has promised on so many occasions over the past four years.

This admission of the blindingly obvious came, funnily enough, after the CPI rate stuck at 2.7% when most economists and commentators, including myself, were braced for a push up towards 3%. With higher fuel prices currently feeding through, we are likely to see 3% breached again, as even King himself now concedes.

Energy costs and other utility bills are having a dramatic effect on incomes that are being squeezed on all sides. With inflation running ahead of wage increases (and I still find it hard to believe that anyone outside the boardroom is seeing pay go up) the average wage is back to 2003 levels. Funnily enough, most of us felt quite well off then and badly done to now, but that’s another story.

Hopes of a recovery in the UK economy have been dented by news that retail sales fell 0.6% in January, with food sales suffering the most. These figures are distorted by the relentless switch from stores to online sales but it is clear that households are in no position to spark an economic upturn.

There is further deterioration across the Channel. The eurozone as a whole contracted in the last quarter of 2012, just as we did in the UK. Statistics can be twisted to show what you want them to do. If you go back six years to the start of 2007, the UK has outpaced the eurozone as a whole, though not Germany and France. If you take January 2008 as your starting point, however, then Europe as a whole has done better – or should that be less badly - than we have.  On that time frame we have fallen way short of the recovery in Germany and France and it becomes clearer by the day that Chancellor George Osborne has no idea how to get us out of the hole. There is no Plan B simply because he cannot think of one.

This is unfortunate because King, who is starting to give the impression that he is demob happy, has spoken two other truths that I have banged on about in this column but have never been admitted officially: that inflation has been caused by the Chancellor (and by Gordon Brown when he occupied the role) and that the Bank of England is limited in what it can do to curb inflation when the country is crying out for growth and the government is scoring own goals.

King has in fact been pretty blunt for the occupant of a post that tries not to take political sides. He points out that ‘green’ utility policies are pushing up bills. I may be reading too much into this but there seems to be a hint that he is sceptical whether this ‘self-inflicted damage’ as he calls it is actually achieving a more environmentally friendly outcome anyway.

He also hinted for the first time that quantitative easing is of limited merit. Some of us have thought all along that the policy, certainly as practised in this country, has been all about keeping down the cost of government debt rather than getting the economy moving. In other words, any benefits there may have been to the general economy have been indirect and by default.

King reckons that he has been asked to run up an ever steeper hill and even holding down interest rates is now having little effect, so that we need to start thinking about what happens when they are raised. Again, this is a belated nod to the real world, where borrowers know that interest rates are much higher than the Bank of England’s base rate.

Unfortunately King’s words will fall on deaf ears in government circles. He is already yesterday’s man even though he has a few tomorrows left to the end of his term.

I thus retain my very cautious, though moderately comfortable stance on shares. I do not in any way expect a sharp fall in share prices. Indeed, I believe that private investors will be inclined to rush into equities between now and early April to mop up their ISA entitlements for the 2012-13 tax year, thus giving an extra push to share prices. This attitude will have been encouraged by press reports that investors are embarking on the ‘great rotation’ that will take them out of bonds and into shares.

I cannot for the life of me understand why ordinary investors were invested in bonds in the first place. They are more complicated and have limited rewards without being particularly less risky. However, it is not a good idea to rush into ISA investments at the last minute just for the sake of it. I did it once, in March 2000, and will not make that mistake again. I have invested all my ISA cash well in advance this time.

Rodney Hobson is a long-term investor commenting on his own portfolio; his comments are for informational purposes only and should not be construed as investment advice.

Market Performance: February 11 - 15

FTSE 100 Index: +1.03%
FTSE 250 Index: +1.37%
FTSE All Share: +1.05%
FTSE Small Cap: +0.22%
FTSE AIM 100: +0.60%
FTSE Fledgling: +1.13%

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About Author

Rodney Hobson

Rodney Hobson  is a columnist for and author of several investing books, including The Dividend Investor and How to Build a Share Portfolio.