Gone a bit quiet on this site recently so my mind has been wandering. Those of you my age or older (mid fifties) remember the good? old days when inflation was the scourge of the UK economy - I had a 12% mortgage!!! The ONS says CPI is at or around 0%, and I see this morning that the retail sales report shows a slight fall in volumes, but a striking fall in year on year shop prices of more than 2%!!

Shop purchases (food, clothes etc.) are far and away my families biggest monthly expenditure, second place goes to council tax and in third place energy.

My kids generation are earning for roughly comparable jobs not much more than I was earning when I was their age (adjusted for inflation, way way less)!!!

Raw commodity prices as a group are at decade lows and still falling (Gold !!!).

My summary.., apart from taxes (there's a surprise), we are in a deflationary spiral and have been for a while, corporate bond yields (YTM) of circa 4% are actually now providing 'real' yields of closer to 6 or 7%.

Is my analysis correct? Is this a long term trend or a bubble? I'd be interested to know the views of other bond investors.


  • I don’t know about a spiral, but it would seem that either negative inflation (economists define negative inflation as something short-term) or deflation is ahead. This is not all bad news, since the purchasing power of money goes up as goods get cheaper. I think companies have been mostly paying next to nothing pay rises for some years, whilst the cost of many things have risen. Governor Mark Carney has consistently said that any period of negative inflation is likely to be temporary, and will not morph into the pernicious deflation seen in countries such as Japan. He said that inflation was likely to climb “above 1pc” by the end of this year.
    I believe that somewhere in the not too distant future we should see a significant correction to the markets. When all this cheap money comes to an end and interest rates begin to rise, the tidal wave of private & personal debt should come home to roost.

    While you’re alleged real yield might be marginally higher in the short term, I’d expect the prices of the bonds will fall as the interest rate rise(s) get closer, cancelling out your alleged real yield. I have sold the vast majority of my holdings as I do not want to be left holding the bag!
  • agree with shotgun

    sold all mine and will just wait for better prices ahead
  • John,
    Your thoughts are very similar to mine, and in fact, I was planning to write something very similar!

    Inflation or Deflation
    My gut feeling is that the UK will not raise interest rates for until at least 2017, Mark Carney with his speculation that "interest rates will rise shortly" will have the opposite effect due to "imported deflation" from Euro land. The Euro declining against the GBP will reduce our exports and keep the lid on "UK Manufacturing industry from being overloaded"
    Little doubt that many young Greeks will be turning up in the United Kingdom looking for jobs, professional or unskilled, thus wage rates are unlikely to increase by any large amount. Europe is too much in the doldrums.

    The picture seems to be brighter across the pond, with today's labour statistics looking better, however with the world importing / exporting so much more, the rising dollar is again likely to curb excessive growth, although lower energy costs will keep the USA very competitive. I suspect any interest rate rises will be very limited.

    The continued decline in raw material prices will prevent any potential build up of "inflationary pressures".

    Significant correction to the UK Equity market.
    I think unlikely, any marginal interest rate increases in the USA would keep UK equities at or just below current levels, UK PLC is not in an excessive boom period, and equities have not done well so far this year. 6566 31st Dec 2014, 6655 today. You may have a long wait for a major correction.

    UK Bond Market
    With inflation staying very close to zero, the bond market will again decide that perhaps "inflation is not around the corner yet". Corporate Bonds will continue to provide positive real returns over the next 5 years (compared to inflation). I will however be limiting my portfolio to further new bond issues with a duration over 7 years. Most of my portfolio is either in Corporate bonds (ORB) or PIBS, with some exposure to infrastructure funds (JLIF & HICL).

    Countries - Keeping the cap on over-valued currencies
    I suspect the CBI is already "bleating" that the GBP is over-valued, and is hurting the UK export companies, likewise many other countries will be trying to keep their currencies competitive, that means keeping interest rates lower or similar compared to your "export market" countries.

    Taxes (Corporate)
    Compared to the 70 & 80's, companies are no longer paying Corporation Tax made up of "inflationary figures". Rates today are much lower, and so are the profits as there is little "inflation element" within them.

    Taxes (Personal)
    Middle Managers today are no doubt being hit if they are paying the higher rate of 40%, however many managers in their 50s & early 60s are "salary sacrificing" for additional employer pension contributions. Some companies even add (contribute) the NI (employers) saving to the employee pension.

    Amateur investor, but a Financial Controller within the manufacturing industry
    (as a company, we just recently reduced our parcel delivery costs by 20% (under £5!), thus UK industry is very competitive!)
  • You appear to have forgotten China! :smile:
  • It seems to me that China is also likely to have a deflationary impact. For the last 10 or so years China was deflationary to our economy in that it caused a drop in the price of manufactured goods imported onto our shores, even if it had an inflationary impact on commodities. Conventional wisdom says China should now be becoming inflationary, however China seems to me to have much the same characteristics (albeit it somewhat bigger) as Japan did in the late eighties and nineties following a boom in the seventies.

    What happened in Japan was the exact reverse of what 'should' have happened and has been neutral to deflationary ever since. China being bigger than Japan may have an even more pronounced effect.

    I dont have a clue about the direction of markets ( I used to work for Merrill Lynch), I'm just pondering the future direction of inflation.
  • China currently has it's own internal problems. The Baltic Dry Index, current figure 1118, compared to 1091 in Feb 2014 & 1888 in December 2011 is not showing any indication that China is taking more "raw materials". China is unlikely to take Europe out of a "deflationary phase", although their finished goods imports (eg cars) must be a welcome blessing for German manufacturing.
    The guts of the problem is that Europe is in a "Fixed Currency scheme", like the old "Gold Standard". A single interest rate applicable for the whole of Europe does not providing a helping hand to "Central Bankers", one country may require support for further growth, and another requires dampening.

    We will wait and see if deflation starts to take hold in Europe. With the Euro depreciating, imported inflation may help to avoid such a situation.

    Difficult and uncertain days lay ahead!
  • Nothing much I could disagree with John or Shaunm, other than to add my own tuppence.

    My view is that rates will remain very low for a very, very long time in the UK and inflation will be low for the foreseeable future.
    In the UK we have some of the highest debt levels in the developed world, both public and household. We also have a very worrying current account deficit, which keeps growing. Our debt/GDP ratio is higher than Spain and many other Eurozone countries. Our debt interest payments as a percentage of GDP is now higher than in 2000-2008.

    We also have a huge problem in housing affordability, particularly in the south-east and some spots across the country: Edinburgh, areas of north-west, south-west, Aberdeen. A base rate increase of 0.25% will add about £40pcm for every £200k of outstanding mortgage balance to anyone with a variable mortgage. Affordability has been stretched so far that if this combines with a Council Tax rise, cuts to tax credits/child benefit or any other increase in expenditure, or bad news like redundancy, a lot of people are going to struggle to make ends meet. Disposable incomes are not going to grow.

    Moreover, an increase in BoE base rate in the next few months will only exacerbate the current strength of Sterling against the Euro. This will be seriously damaging to what little is left of our exporting industry and will further damage the current account deficit. The so-called rebalancing of the UK economy is impossible if the base rate increases whilst the Euro base rate is stuck at nearly zero. UK industry would suffer enormously, but the Germans/ECB would be happy to see the Euro devaluate further in order to boost their own competitiveness.

    In summary: increases in the base rate would further damage the current account deficit, would increase the cost of gilt interest repayments, will reduce disposable income, will make our exporters less competitive, but would make imports cheaper thus damaging profit margin of our own producers even if they don’t export. Furthermore, we are likely to see a continuous influx of qualified labour from countries like Spain, Greece, Portugal, etc, as ambitious young people escape unemployment rates of 25% in their own countries.
    (I know because I left nearly 20 years ago). This will keep salary inflation in check for both skilled and unskilled labour unless the Government introduces restrictions to the free movement of EU citizens, something that seems unlikely for now.

    So I don’t see base rate increasing in any significant way any time soon and I think that Mark Carney’s warnings about an impending rate rise are now becoming irrelevant. Even if we get a 0.25% increase in 2016, the Bank will probably wait many months before increasing again by another 0.25%. It will be a very long time before we get to 2%, if we ever get that far. Japan hasn’t.
  • Trenator, 100% in agreement, plus your wording much better than mine!
    I will to continue to hold corporate bonds for at least another 2 or 3 years minimum, if not longer. Not only earn on average 5% income per annum, but also hope for a capital gain when I sell them closer to maturity (12 to 18 months), when corporate treasury departments start investing for the final months of maturity.
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