EWU: The Entire United Kingdom Is In Trouble

Production is the only answer to inflation. - Chester Bowles.

The economic landscape in the United Kingdom, as covered by iShares MSCI United Kingdom ETF (NYSEARCA:EWU), is undergoing a tumultuous phase, with inflation rates soaring to unprecedented levels. A recession may be needed to break the fever.

A Growing Threat: Stubborn Inflation

The UK's inflation rate has become a stubborn economic adversary, refusing to back down as anticipated. According to YCharts, UK Core Inflation Rate is at 7.10%, compared to 6.80% last month and 5.90% last year. This is higher than the long-term average of 1.90%.

The key driver of inflation has been the rapid increase in prices for recreation, cultural activities, and food. The cost of airfares, second-hand cars, live music events, and computer games has risen significantly, contributing to the stubbornly high inflation rate.

The Bank of England's Strategy: Interest Rate Hikes

In response to the growing inflationary pressures, the Bank of England has opted to raise borrowing costs. The Monetary Policy Committee voted 7-2 to increase the main interest rate to 5% from 4.5%, marking the highest rate since 2008.

This decision was in part due to the failure of inflation in the UK to ease as quickly as anticipated. The Bank of England Governor, Andrew Bailey, warned of further rate hikes if inflation fails to show clear signs of downward movement.

The Impact on Mortgages and Housing

The decision to raise interest rates has far-reaching implications for the housing market. The interest rate on the typical UK mortgage, a two-year fixed-rate loan, has been climbing since the start of May. With further rate increases expected, this could lead to a significant rise in mortgage payments for homeowners.

As a result, homeowners are facing what some have termed a "mortgage bomb." With around 800,000 fixed-rate mortgages set to expire in the latter half of this year, the prospect of an unaffordable jump in payments when borrowers refinance is a very real concern.

And to be clear, Housing must fall for inflation to fall.

The Global Implications: The Role of the UK in the World Economy

The UK plays a significant role in the global economy, and the current inflation crisis could have implications beyond its borders. If the UK does indeed need to create a recession to curb inflation, this could potentially impact global markets, affecting everything from global trade to foreign exchange rates.

It's been brutally difficult to playing UK equities on the long side. The iShares MSCI United Kingdom ETF has seen a downward trend, underperforming the U.S. stock market's S&P 500 (SP500) pretty meaningfully, and it's hard to see this reverse any time soon on a secular basis.

Looking Ahead: Halving Inflation

UK Prime Minister Rishi Sunak has promised to halve inflation to around 5% this year. However, with inflation persistently high and the Bank of England resorting to rate hikes, this task looks increasingly daunting.

The Bank of England's decision to raise interest rates has placed the UK in a precarious situation. If the rate hikes fail to curb inflation and instead trigger a recession, the UK could face a significant economic downturn.

The UK's economic landscape is fraught with challenges. The stubborn inflation rate, coupled with the Bank of England's drastic measures to combat it, presents a complex situation that could potentially lead to a recession. As the UK grapples with this economic predicament, it serves as a stark reminder that we are NOT out of the woods on inflation or even stagflation risk. I personally would not touch investing in the United Kingdom now, although a spread trade against the U.S. could be interesting.

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