These days, Brazil and the UK may be miles apart in terms of footballing prowess, but the countries do at least share one surprising commonality: a 3% inflation rate. For two countries that had diverged so much post the 2008 financial crisis, we are now back to square one which is important because inflation is a crucial concern for any bond investor, whose income can be eroded by high inflation.
Annual Rate of Inflation
Source: Bloomberg and underlying index provider(s).
The past few years have not been the UK’s finest, especially when it comes to politics. Having failed to quieten the Euro sceptics within his own party and secure the country’s vote to remain in the European Union, the Prime Minister David Cameron immediately announced his intention to resign; once in office, his successor Theresa May, tried to shore up her position by calling a snap general election. This too backfired, resulting in a hung parliament. And with the clock ticking down to ‘Brexit’ in April 2019, British negotiations have yet to secure much in the way of progress from their European counterparts.
Add to this the well-known structural issues affecting the UK economy – an overvalued housing market, a large current account deficit and, currently, one of the highest inflation rates in the developed world – and you begin to see why all three of the large rating agencies have taken away the country’s prized AAA credit rating in the past five years on concerns over the challenges ahead.
Image: A mural by street artist Banksy depicting a European Union flag being chiseled by a workman in Dover. © Bloomberg/Getty Images.
If politics have been a dampener on UK prospects for economic growth in recent years, Brazilian politics have been on the up following the impeachment of its President, Dilma Rousseff and the demise of her government in late 2016. Since then, the new president, Michel Temer, has shown that he is determined to improve the long-term sustainability of his country’s public finances. He has introduced a freeze on government spending, and is pushing through pension and labour reforms to tackle Brazil’s deep-rooted welfare state and high levels of unemployment. We think this positive policy trajectory is likely to remain, whomever wins the upcoming presidential elections in October this year.
Like the UK, Brazil has its structural challenges, but it is in a much more comfortable position having emerged from its worst-ever recession on record in 2015–2016. This recession, in part triggered by the collapse in commodity prices in 2014, crushed domestic demand. The consequent reduction in imports helped to improve Brazil’s trade balance and has made it easier for the Central Bank to reduce domestic interest rates, on the back of faster-than-expected falls in inflation. With lower interest rates and improving confidence, growth has improved to 2.1% and is expected to rise further.
Image: Famed mural painted by artist Eduardo Kobra for the Rio 2016 Olympic Games on May 12, 2017 in Rio de Janeiro. © Getty Images South America.
A country’s current account balance is an important indicator of the nation’s economic health as a measure of the country’s savings and spending in the same way that our bank account balance might provide some insight into our personal finances. While both the UK and Brazil are currently in deficit, the changing fortunes of the two are perhaps best illustrated in the chart below, with Brazil’s deficit showing a notable correction since the recent recession.
Source: Oxford Economics.
Brazil has responded to the challenges it has faced through a reduction in consumer spending and a higher level of savings. As a result, it should be much less vulnerable to external shocks in the form of rising US interest rates and a change in global investment flows.
On the other hand, the UK has yet to correct its spending imbalance. Its current account remains uncomfortably negative and has been so for more than a decade. So much so, that is now larger than that witnessed before the last major UK recession in the early 1990s, when London house prices fell over 30% and the pound suffered a significant devaluation. The low savings rate and high levels of household borrowing in the UK has kept consumption levels high, and the country remains vulnerable to external shocks.
Times have been tough for Brazil, but maybe now its time for the UK to toughen out a rebalancing?
The views expressed in this article are those of Sally Greig and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford Life Limited is authorised by the Prudential Regulation Authority (PRA) and regulated by the FCA and the PRA. Baillie Gifford & Co Limited is a unit trust management company and the OEICs’ Authorised Corporate Director.
Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.
Persons resident or domiciled outwith the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.
Baillie Gifford Asia (Hong Kong) Limited 百利亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 licence from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of UCITS funds to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 百利亞洲(香港)有限公司 can be contacted at 30/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong. Telephone +852 3756 5700.
Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.
Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.
This material is provided on the basis that you are a wholesale client as defined within s761G of the Corporations Act 2001 (Cth). Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth). It is exempt from the requirement to hold an Australian Financial Services License under the Corporations Act 2001 (Cth) in respect of these financial services provided to Australian wholesale clients. Baillie Gifford Overseas Limited is authorised and regulated by the Financial Conduct Authority under UK laws which differ from those applicable in Australia.
Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.
Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in America as well as some marketing functions in Canada. Baillie Gifford Overseas Limited is registered as an Investment Adviser with the Securities & Exchange Commission in the United States of America.
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.
This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.
All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.
The images used in this article are for illustrative purposes only.
This communication was produced and approved on the stated date and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
Ref: 32888 ALL WE 0105