Inflation: What do the experts think?

UK inflation continues to climb, the consumer price index surged to 2.1% in the 12 months to May, this is up from 1.5% in April and also breaks the Bank of Englands target 2% for the first time since 2018. So what do the experts make of this?

On the Economy

Sam Pham Investment Strategist at Tilney Smith & Williamson tackled the headline figures in a bit more detail Pham pointed to areas of the economy that came in line with expectations, such as the Retail Price Index and the Producers Price index (3.3% and 4.6% respectively).

Pham suggested, “Although inflation came in higher than expected, the details showed price increases to be consistent with reopening of the UK economy post Covid-19.”

They continued, “In particular, key drivers of high price increases came from base effects, higher energy prices, as well as jumping restaurant and hotel prices, among others.”

This premise is echoed throughout the industry, as the economy reopens supply bottle necks and pent up demand has caused inflation. Jonathan Letham, Head of IMX, Nucleus said about this, “global inflation is to be expected.”

Letham contniued on this note saying the inflation spikes we have seen in the UK and across the pond are “likely a transitionary phase.”

However many experts are maintianing a cautious position, as Pham suggests, “It remains to be seen if high inflation is transitory or not.”

Derrick Dunne, CEO of Beaufort Investment, was a bit more brazen about the state of the economy, saying, “Clearly, an impressive economic recovery is coming.”

Also positive, Ian Warwick, Managing Partner at Deepbridge Capital, said, “Today’s inflation data serves as further evidence that that the UK economy is moving in the right direction at a significant pace.

Dunne continued his analysis with dampening caution, positing, “The Bank of England may soon have to take tightening measures.”

Dunne continued, “The breach of the Bank’s stringent 2% target may already be provoking discussion of a monetary policy adjustment. Investors should still ensure that their plans can withstand both inflationary pressures and a potential rise of the base rate. At this stage, nothing is off the table.”

Luke Bartholomew, Senior Economist, Aberdeen Standard Investments was a little more confident of central bank resolve saying, “We are not especially concerned that this increase in inflation will persist. Once the one-off effects currently buffeting the economy have passed, inflation should start to moderate as spare capacity weighs on price pressure.”

“So for now there is little reason for investors to worry that the Bank of England will soon be withdrawing its monetary support.”

But what does this ambiguity mean for investors?

Letham summarises investors’ concerns nicely, “Despite the rises in inflation, central bankers in the US, UK and Europe are indicating they will maintain loose monetary policy (i.e. keeping interest rates low) to support economic recovery.”

“The fear for investors is that the central banks stimulus combined with economies reopening could lead to prices spiralling higher and hurt real returns over the longer-term.”

Jason Borbora-Sheen, Co-Portfolio Manager of Ninety One, gave an in depth overview for the investment landscape, which we’ve included below in full;

If 2021 inflation moderates, it is likely that more defensive sectors can outperform, those such as REITs or Healthcare. If inflation attains higher levels in 2022 then this would potentially negatively impact the winners of recent years, such as tech stocks, the US equity market relative to the rest of the world, and longer-duration fixed income. The combination of faster nominal growth globally, and easy policy could also weaken the US dollar. The beneficiaries are likely to be traditional cyclical sectors, short duration, emerging markets in general, and commodities”

 To get an accurate gauge on inflation, investors should monitor global inflation rates, not just in the Eurozone and the US but also in China where CPI has been low, alongside alternative measures of inflation such as real-time  online prices, and market-based measures such a break-evens. Should inflation continue to move higher, then this increases the pressure on the US Federal Reserve to tighten policy, this could create a more positive correlation  between equity and bond prices and investors should consider duration and equity hedging.

We believe that to take advantage of an inflationary scenario, it is important to have a cross-asset, flexible approach to security selection and risk management. In the near-term we think short US inflation-swaps are a compelling way to take advantage of elevated expectations of inflation that may be disappointed, we also think owning rate-sensitive equities such as REITs that have been hard-hit over the last year have asymmetry to returns. As we move later in the year and into 2022, short interest rate swaps or bond futures become more attractive, particularly in Europe.