Pegasus Capital

Petrol & Oil currently make up 35 parts per 1000 within the RPI according to the ONS, or 3.5% of the Index. The weighting within the CPI index is lower, nearer 22 parts per 1000 or 2.2% of the index.

Using the £ level of Brent, pump prices could fall as much as 8-10% over the next 3 months, shaving what could be around 0.3-0.35% off the RPI index.

UK break-evens have been immune to the sharp fall in oil prices so far because of the focus on risk premia surrounding a hard or no-deal Brexit. Given the distinct lack of tolerance for a no-deal exit, the short-end of the UK inflation-market needs to tread very carefully in terms of sustaining such a risk premia in the face of softening fundamentals for the actual inflation rate.

Within the November QIR the BOE had CPI at 2.18% at end Q1 2019 before the sharp fall in oil prices (they used $81 Brent as Q4 condition within the model, versus $63 spot!). By the spring of next year, if oil prices remain near current levels, we could be looking at an RPI yoy rate of nearer 2.7-2.8% at that time, some 90bp below current 5-year RPI rates.

In essence, UK RPI already looks fully priced for a move down to the 1.15-1.20 level in GBP/USD, so the value of the no-deal hedge looks much less obvious.

Petrol Vs Brent
Petrol Vs Brent

PegasusCapital - 21/11/2018

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A View From The Bridge - May 2020 (2)

The risks of a deflationary outcome remain very elevated. Our understanding of likely household responses is becoming more informed, particularly with regard to genuine uncertainty, precautionary savings balances being built (where possible) and the likely consolidation of credit related debt. Turning the tide on the risk of viral infection and saving lives is the driving policy of government, but by definition this just pushes another rising tide of shrinking demand onto the economy.

PegasusCapital - 07/05/2020