There has been a recent media focus on inflation, the threats it poses, and potential solutions to combat it. With prominent figures such as Andy Haldane, Chief Economist at the Bank of England stating publicly that they see a real risk of inflation being “more difficult to tame” this year and “requiring monetary policy makers to act more assertively than is currently priced into financial markets” (Bank of England, pre-recorded speech) it is clearly an area of concern for investors.
While no one is suggesting that we will see hyperinflation in the near future, even a relatively small increase in prices can have a significant impact on the value of capital, especially when interest rates are so low. So, how concerned should we be by the threat of inflation?
Context is king
As with any of the data points we consider, it is important to look at inflation figures within a wider context – especially as we come out of a global pandemic and a succession of lockdowns around the world. Starting from an unusually low level during the reduced consumption levels triggered by the restrictions placed on both producers and consumers in 2020, the growth in prices used to measure inflation may look higher than usual, possibly even to an alarming degree.
The price of oil is a good example of this, as it is highly sensitive to changes in demand and saw huge falls as populations were instructed to stay at home as much as possible for long periods of time. As global economies recover, there will be a stark contrast to where we were this time in 2020 – a sign, in fact, of how things are improving.
However, just because the phenomenon is transient and relative doesn’t mean it won’t spook the market. We have seen over recent years what a fear of rises in interest rates can do to markets with the recent ‘taper tantrums’ in which both equities and bonds fell simultaneously.
Huge fiscal stimulus in many regions (not least the US, who look likely to pass economic support measures totalling over $1tn) could increase spending significantly and boost inflationary forces. A rapid increase in spending, as is expected in the UK in 2021, can also add significantly to inflation, as the economy begins to recover and spending resumes.
However, the spare economic capacity left by the coronavirus pandemic – namely higher un-employment and under-employment, and relatively low consumer and business confidence levels – should be enough to mitigate much of this.
How concerned should we be?
While we see that inflation is on the horizon, we believe that it is not something we need to prepare for immediately. If the global economy recovers as we hope, we will have to reconsider this at some point in the next few years, and we will remain watchful for signs of its effects on markets.
The forecast for the global economy puts growth likely to be close to 6.5% in 2021 and around 4.5% in 2022, and this should bring reflation with it. Central banks may need to increase interest rates on inflationary grounds but not until around 2023 or, more likely 2024 – it is difficult to see this happening before then.
Once this does happen, it is likely that we will prefer the natural inflation protection of equities and ‘real assets’ (specifically commodities, some commercial property and infrastructure) to mitigate its’ effect.
The headline-grabbing figures that we are already seeing, and will see for the months ahead, may alarm some – possibly some of your clients – but at this point it is merely the effect of things being significantly more positive than they were this time last year. We do anticipate inflationary pressures in the next few years but in a growing economy this is natural, expected and welcome, as long as it does not get out of hand. In the shorter term, we see no reason for alarm and we instead suggest that we should remain cautious.