Investment Management Blog - Montague Capital

Just how well EdF’s announcement of immediate price rises of 17% for electricity and 22% for gas conforms to the Bank of England’s game plan for inflation will be a critical factor in next week’s interest rate decision.  That plan always assumed that inflation would move away from the 2% target before it fell back, suggesting that the MPC would not need to react to every piece of bad news if it stayed calm and looked far enough down the road to a happier future.  Unfortunately for the public perception of that plan, in recent weeks the MPC has become more pessimistic about just how much higher inflation would go and how long it would stay there.  This, in turn, does nothing to reduce the risk that rates might have to rise.  But has that pessimism been based on an accurate prediction of what the utility sector would do to us?  Or will Friday’s price rises have come as a nasty shock?  After all, if the MPC had been looking at the wholesale gas market to form its opinions, it might have been encouraged by the 15% fall seen in that market in recent weeks. Unfortunately for the MPC, the utility companies are driven solely to maximise their profits and have no sense of a wider macroeconomic responsibility.  We haven’t heard much since the first council workers’ strikes two weeks ago, but should we really think that a one-fifth increase in fuel bills will now lead union negotiators to ask for less money?  It doesn’t matter to them that utility companies choose not to share lower wholesale prices with us and that a different outcome might have been possible.  Union negotiators only exist to promote their members’ interests.  So far the MPC has managed to duck the issue, but at some stage it will have to show that it’s serious about discouraging a mindset that companies can charge what they like because consumers will always bully out the cash to pay higher prices.  And, to make matters worse, the utility companies have not suggested that they will no longer need the winter price increases they have already threatened us with.  Perhaps energy prices didn’t matter in the greater scheme of things when they were so cheap.  But now that fuel takes up 10% of the average household’s expenditure, the gearing effect of today’s price rises means it sure as hell does.  But “irregardless” (as Junior would say) of what all this means for the inflation and interest rate debate, it is unreservedly bad news for the economy.  If UK Plc had not over-extended itself so ridiculously on borrowed cash we would not be in anything like as bad a mess, but it did and recession is the price that now has to be paid.  One more slice of the costs picture gets racked up, squeezing company profit margins and households’ disposable income.  “Tails I win, heads you lose.” 

Banking 

The next bit of fun in store for us over the next fortnight will be the banks’ half-year trading updates.  Do not expect many instances of an apparent ability to deny economic gravity.  All of them are expected to report lower (but still indecently large, if you are a suffering customer) earnings, but it is the condition of their balance sheets that will come in for the closest scrutiny.  (Can Lloyds TSB still afford that generous dividend, at least in hard cash?)  Some parts of the weekend press speculated that another round of capital raising will become necessary before the end of the year.  If it did, would the sovereign wealth funds be keen to submit to this shoddy little scam yet again?  Backers of Barclays will have little patience left, having been stuffed first for the failed tilt at ABN Amro and then for the recent rights issue.  “Throwing good money after bad” and all that.  None of the conditions that caused the collapse of the sector in the first place has truly gone away.  The wholesale money market is closed for business, “toxic waste” still exists and has a current market price nowhere near what it is still being carried at on banks’ balance sheets, and house prices continue to slide with all that means for the quality of the mortgage book.  But now we also have to cope, as we didn’t a year ago, with the imminent prospect of recession, which does little to reduce the scope for corporate defaults.  We read of hedge funds setting up specifically to buy into “distressed” banks, but finding themselves unable to commit to whether the bottom will be reached in one week, one month, one year or longer.  They have to say banks are good, or they would have no chance at all of attracting clients.  However, that lack of legally watertight clarity should sound a major warning bell.  But of all the negatives listed above, imminent recession is one that is hardest to argue away.  This government is in no position to find a fiscal policy that will make the threat go away, nor can the MPC help until inflation is credibly heading in the right direction.  Best not to dwell for too long on what banks say in private about their true prospects.  In the short-term, the only thing this sector has got going for it is M&A activity.  That’s no more than a lucky dip.