The Brexit vote and inflation updated evidence

European government yields produced larger moves than the US as economic activity remained subdued. Peripheral Europe outperformed core markets, supported by a cautious tone from ECB President Mario Draghi as he acknowledged downside risks to the economy. Italian and Spanish 10-year yields each declined by around 20 basis points (bps), while French yields also declined markedly. The latest increase in the consumer prices index took the measure of inflation to the highest rate since March 1992, when it stood at 7.1%. Further increases are expected as higher motoring costs triggered by Russia’s invasion of Ukraine and April’s increase in domestic energy prices take effect.

The database also provides aggregate inflation for global, advanced-economy, and emerging market and developing economies as well as measures of global commodity prices. It is clear that the average British household is already paying a price for voting to leave the EU. Households that buy a lot of imported goods have faced bigger price rises than households that mostly purchase products produced in the UK. This allows us to study the distributional consequences of the Brexit vote. Economic theory predicts that a strong and sustained depreciation of a country’s exchange rate should lead to an increase in inflation. In fact, CPI inflation in the UK rose from 0.4% in June 2016 to 2.6% in June 2017 and 3.0% in October 2017.

Actual costs rather than forecast costs

To measure import dependence, we calculate the share of imports in consumer expenditure for different products, taking account of both final good imports and imported inputs used by UK producers. In recent research (Breinlich UK Inflation Update January 2019 – et al. 2019), we analyse the effect of weaker sterling on UK consumer prices. As Figure 1 shows, the import-weighed effective sterling exchange rate depreciated by about 10% immediately after the 2016 referendum.

• The yen appreciated sharply against all currencies on 2 and 3 January before gradually retracing most of the move to end just 0.7% stronger against the US dollar for the month as a whole.
• Although the Fed left its headline policy rate unchanged, it highlighted a greater degree of flexibility in future rate decisions, confirming any changes will be based on economic momentum.
• All investments involve risks including the risk of possible loss of principal.

This means that when sterling depreciates, the price rise for each product group is given by the product’s import share times the magnitude of the depreciation. Textbook economics predicts that imported goods and services will rise in price if the exchange rate depreciates. We examine this mechanism in detail using consumer price data collected by the Office for National Statistics (ONS) to compute the official UK consumer price index (CPI). The key variation we exploit to tease out the effect of the weaker exchange rate is the difference in import exposure across 84 product groups.

Designing fiscal policy at a time of accelerating prices: Italy under Mario Draghi

UK equities performed well over the month, rising 4.2% (FTSE All-Share), although lagged global equities as the market’s significant defensive constituency trailed with the return of risk appetite. Sterling strength was another headwind which held back the more internationally focused FTSE 100, which rose by 3.6%. GDP figures showed growth of 0.2% quarter-on-quarter in Q4, the same as in Q3. Italy slipped into recession with two consecutive quarters of economic contraction. In terms of forward-looking indicators, the flash composite purchasing managers’ index[1] fell to 50.7 in January, a 66-month low and compared to 51.1 in December, suggesting that business growth is close to stalling. The unemployment rate remained stable in December at 7.9%; this remains the lowest rate since October 2008.

Business groups and Labour warned that the chancellor needed to take urgent action to address rising living costs in his spring statement. Sunak will announce his set-piece tax and spending update to the Commons on Wednesday afternoon, with expectations that additional support for households will be announced. Figure 2 provides descriptive evidence on the tight relationship between a falling exchange rate and rising import costs. It shows that after June 2016 as sterling went down, intermediate input import prices rose rapidly. Turkish stocks, particularly financials, traded up as overseas investors returned in their search for higher yield.

United Kingdom (UK): Inflation rate from 1988 to 2028

This surprised markets; risk assets rallied and the US dollar weakened. The MSCI Emerging Markets Index increased in value and outperformed the MSCI World. We next look at the impact of higher prices on household expenditure and living standards. We find that the average household has https://accounting-services.net/depletion-region/ to spend £7.74 more per week, or £404 more per year, to afford the same purchases. By increasing prices without affecting nominal wage growth, the referendum has also reduced real wages, costing the average worker almost one week’s wages (4.4 working days’ wages, to be precise).

Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. In this environment, all markets closed higher except India, where the rupee weakened on growing fiscal concerns. By contrast, Taiwan underperformed as the outlook for the country’s technology heavyweights dimmed amid slowing global smartphone demand.

The persistent fall in the sterling exchange rate

First, the sudden drop in sterling was unusually large for an advanced economy. As Costa et al. (2019) point out, this was the sharpest exchange rate depreciation to occur in any of the world’s four major currencies since the collapse of Bretton Woods. Second, despite some short-lived appreciations (Manasse et al. 2020), the drop in sterling has proved unusually persistent. As of writing, sterling stands at $1.30 against the US dollar and €1.20 against the euro.

The weaker performance compared to global equities was partly a function of the UK large caps having outperformed at the end of 2018. That was when fears around the outlook for the global economy, future path of US monetary policy and political uncertainty reached a head. Sterling bounced back in January as hopes built the UK would avoid a “no deal” Brexit. Britain’s cost of living squeeze intensified further last month, according to official figures showing inflation reached 6.2% in February – announced before Rishi Sunak’s spring statement. From a researcher’s point of view, the referendum and the resulting depreciation of sterling can be regarded as an exogenous macroeconomic shock that was sudden, strong, and persistent. Our research is the first attempt to trace out the economic consequences of the referendum shock using detailed econometric analysis.

Asia ex Japan equities rebounded in January amid growing optimism that the trade standoff between the US and China would be resolved. Concerns over China’s deepening economic slowdown limited gains, however. Chinese exports declined 4.4% year-on-year in December, the biggest monthly fall in two years.

• Corporate bonds produced a strong rally and outperformed government bonds with spreads narrowing significantly.
• Our estimates imply the Brexit vote increased UK CPI inflation by 1.7 percentage points in the year following the referendum.
• That was when fears around the outlook for the global economy, future path of US monetary policy and political uncertainty reached a head.
• Chinese exports declined 4.4% year-on-year in December, the biggest monthly fall in two years.
• Updating the analysis using more recent data, we estimate that the Brexit depreciation increased UK consumer prices by 2.9%.

Our results imply that exchange rate pass-through to the overall consumer price index from the Brexit depreciation equals the aggregate import share. Since this import share is 29% for the UK (see Table 1) and since sterling depreciated by about 10%, we estimate that the Brexit depreciation increased consumer prices by 2.9% by June 2018. This is equivalent to an increase in the cost of living for the UK average household of £870 per year.