UK headline consumer price inflation (CPI) falling to 7.9% having been stuck at 8.7% in April and May is welcome news. Of course the rate is still running at four times the Bank of England’s monthly target of 2% and the pressure is not yet off the Bank to raise base interest rates at least once more. Its next policy meeting is on August 3rd. Whether it raises rates by a quarter-point (increasingly the consensus view) or by another half-point as was the expectation before the latest inflation data, or does not raise them at all as some including a minority of members of the Bank’s own policy committee maintain should be the case, remains a moot point. Weighing in the mix is that core inflation which excludes the more volatile elements of fuel, food, alcohol and tobacco while falling to 6.9% in June from 7.1% in May, remains higher than it has for the last 12 months. Economists are predicting/hoping that stronger sterling taking the pressure off imports, and the ‘base effect’ (i.e. as the annualised measurement time series moves on each month and the price comparators become increasingly easy, mathematically it pushes down the inflation rate) will both provide tail winds in the second half of the year. They and the government will also be hoping that as the core rate now subsides below the average rate of private sector wage inflation currently averaging 7.3%, the upward pressure on wages will begin to abate too.

However, what is seldom talked about is the Retail Price Index (RPI) which includes housing costs. No longer the official inflation measure, nevertheless in a hangover from the days a decade ago when it was, it is still used extensively in government and regulated business. Among others: index linked gilts; National Savings Certificates; a host of excise duties including transport, gaming and alcohol taxes; interest payment calculations on student loans; regulated prices including season rail tickets. Down from 11.3% in May, RPI in June was still in double digits at 10.7%. While the prices of commodities etc are cyclical and volatile, many of the items above have their ‘prices’ set and locked for the following year based on RPI at a particular date. Take for example season tickets: the annual fare increase for the whole of 2024 will be set using the published RPI figure for July 2023; even if underlying inflation is falling for other reasons towards the end of the current year, the cost of season tickets will be baked in for all of next year at today’s relatively high rate (clearly, the system works to consumers’ benefit at the other end of the cycle: when inflation has troughed and is beginning to accelerate the price pain is delayed).

Most of these RPI-related items are generating income for the government. However, the indexation of 25% of government debt is a direct cost when inflation rates are high. For example in April, the government’s total interest bill was £9.8bn; £6.2bn (63%) of that was directly attributable to the index-linked proportion: crudely, a quarter of the debt in issue being directly linked to inflation and RPI in particular, which is almost invariably higher than CPI, accounted for two thirds of the cost of servicing the government’s total borrowings.

As we continue the theme we have been discussing in these columns for some months about the pernicious effect of the heightened cost of capital linked to elevated inflation, more evidence of stormy waters.

In the UK we have already seen the well-publicised travails of Thames Water, struggling under the weight of a significantly over-borrowed balance sheet and having to work hard to convince investors of the merits of refinancing its bonds to prevent it becoming insolvent.

In France, the major food retail chain Casino is in financial difficulty and needing robust remedial reorganisation measures after warning of an impending default on its bonds.

Again, in the UK (and linking directly with last week’s Merlin column discussing the financial viability of UK offshore wind economics without a new round of government subsidies), citing inflated construction costs and specifically the increased cost of capital, this week the Swedish energy company Vattenfall has shelved its proposed development of one of the world’s biggest offshore wind projects (referred to by one commentator as a ‘turbine forest’) off the north Norfolk coast. We are regularly told by the green energy industry and its lobbies that wind is the cheapest form of energy. So cheap it is apparently unaffordable! What does not help in these discussions about the financial viability of such projects is the harsh but obvious truth of producing renewable electricity from unreliable and unpredictable sources: on the same day as the Vattenfall announcement, SSE, the Scottish power generator, has blamed the weather for a 29% drop in output from its renewables division in the second quarter, largely because of prolonged periods of high pressure which sat over the UK. No wind equals no electricity equals no revenue, but the meter is still ticking on the fixed costs and cash outflows of operating, maintaining and financing those industrial turbine installations while their blades are immobile.

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.