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Statistical 'State of Abnormality' Has Been Biasing Inflation Lower

Statistical 'State of Abnormality' Has Been Biasing Inflation Lower
(Maksym Yemelyanov/Dreamstime)

By    |   Tuesday, 12 September 2017 01:13 PM

Politics overnight went largely as expected.

The United Nations passed some pretty diluted sanctions against North Korea, and after keeping the situation tense, not enough to provoke a veto from the Russians or the Chinese. There is nothing that markets are likely to regard as new information in any of this.

Meanwhile, the British government won a series of votes enabling them to turn the clock back to the 1530s using late medieval devices to enable the United Kingdom (U.K.) to exit the European Union (EU).

Believe me, there is a lot more to come of this.

Parliamentary scrutiny in detail of the committee stage is an issue.

Nevertheless, this was the first significant test for Mrs. May’s government somewhat precarious majority on European matters.

Again, this is the outcome that does not affect markets. A different outcome would have provoked a serious reaction.

This leaves us able to look at some data today with some relief.

There are inflation releases from Sweden and the United Kingdom (U.K.), and both, for different reasons, are worthy of investors’ attention.

Swedish consumer price inflation (CPI) has been surprising to the upside in recent months, although the Riksbank’s (Sweden’s central bank) behavior would not suggest that.

Swedish CPI eased a notch to 2.1 percent year-on-year in August from a five-and-a-half year high of 2.2 percent in July and slightly below market expectations of 2.2 percent.

At lower inflation levels, central banks having been largely been successful in achieving what economists consider “price stability.”

The importance of a statistical “state of abnormality” increases in the inflation data.

Statistical “state of abnormality” has been biasing inflation lower in several globally important economies, which includes the United States.

Now, Sweden ranks twenty-third on the IMF’s 2016 world rank list, based on nominal or current prices in 2016.

Well, Sweden reminds us that the bias in inflation can run both ways, which is important for any investor to keep in mind.

The U.K. inflation price data is somewhat different.

The U.K. inflation story is impacted by the decline of the British pound sterling. This is unusual as currencies have normally a very limited passthrough to final inflation data, but the nature of the sterling decline, large and structural, makes this more of an exception to the rule.

Anyway, today the British pound jumped to a five-week high of $1.3224 at 9:30 AM London time after U.K. inflation figures came in stronger than expected.

Consumer prices in the United Kingdom rose by 2.9 percent in the year to August 2017, beating market expectations of 2.8 percent and following a 2.6 percent gain in July. The annual core inflation rate, which excludes prices of energy, food, alcohol and tobacco, rose to 2.7 percent, also above market consensus of 2.5 percent.

Investors that have investments that are “dollar-based” should better not look for parallels between the value of the U.S. dollar and the British pound, and notwithstanding that both currencies are used as global “reserve currencies.”

Now, and this is important, on September 1, Norway’s sovereign wealth fund, which is one of the biggest in the world, announced in a letter to the Norwegian Finance Ministry dramatic changes to the composition of its $333 billion bond portfolio whereby it will pare its bond index from 23 currencies to include only securities denominated in dollars, euros and British pounds (!)

For investors, there are excerpts of that letter that are worth being taking note of: “In the long term, the gains from broad international diversification are considerable for equities but moderate for bonds … For an investor with 70 percent of his investments in an internationally diversified equity portfolio, there is little reduction in risk to be obtained by also diversifying his bond investments across a large number of currencies.”

Interestingly, recent research by the Bank of England suggests that even with the drop in sterling there is a tendency to pass on less of the inflation effect to the consumer than a pure economic model might suggest, such as the competitive nature of the UK retail.

This means that while the U.K. inflation data has increased, it is not expected to increase U.K. competitiveness as much as might be supposed.

That then, yes, has to be considered in the context of full employment when contemplating the living standards of U.K. consumers.

This counting average hourly earnings with consumer price inflation tells no one anything about real living standards because statistics are too distorted.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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Investors that have investments that are “dollar-based” should better not look for parallels between the value of the U.S. dollar and the British pound, and notwithstanding that both currencies are used as global “reserve currencies.”
investors, investments, dollar, pound
Tuesday, 12 September 2017 01:13 PM
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