But in today’s paradoxical world, inflation has continued to decline in spite of several factors which would traditionally have the opposite effect.
Miton’s Martin Gray, M&G’s Jim Leaviss and Kames Capital’s Stephen Jones lay out their cases for and against a near term inflationary scenario.
The case against inflation: Martin Gray
Miton’s Martin Gray (pictured) says he has been firmly in the non-inflationary camp since the turn of the century but with the rising tide of money sloshing around the world, he was becoming increasingly concerned about inflation creeping in at the start of the year.
However, over the last few months his fears have abated and he’s now more worried about deflation in the near term. “The risk is more to deflation than inflation in the next 12 months,” he said.
“It’s not a huge concern for me, but there is real worry that Europe is dragging the rest of the world down with it.”
The FE Alpha Manager says economic data in Europe is horrible and if another black swan event, such as the crisis in Cyprus, took hold, it would threaten to sink the global economy.
He says with monetary easing from the UK government, and other developed economies, there was understandably a lot of conjecture that high inflation would follow.
“The question is when will all this money sloshing around the world find its way into the real economy and subsequently inflation. But we’re not seeing it at the moment.”
“QE is not really entering the real economy and not affecting many people as far as I can tell,” he said.
Gray says the trifecta of low economic growth, low wages and low commodity prices is keeping inflation at bay.
“I’m not expecting consumer demand to pick up because we’re still seeing negative real earnings growth. People's real take home income, even with low inflation, is flat and falling.”
However, Gray says the one surprise in the current economic scenario is commodity prices, which rather than going up as expected, have in fact plummeted in recent weeks.
“In a risk on/risk off environment with QE, commodities should go up, but in the last six months we haven’t seen that at all. In fact, we’ve seen the reverse,” he said.
“We’re seeing inflation numbers, as you know, at very low levels and core inflation in the US is coming down to very low levels.”
The UK’s headline rate of inflation – CPI – was just 2.4 per cent in April, down from 2.8 per cent in February and March.
Performance of index since January 2013
Source: FE Analytics
According to the most recent inflation figures measured by the retail prices index (RPI), inflation fell to 2.9 per cent in April from 3.3 per cent the month prior.
“At the moment, the market is completely unconcerned about that, but any sniff of moving lower, people should be more worried about deflation again,” he said.
Gray says if investors are concerned about inflation protection, there is little they can do in the current environment because yields are so low.
“I’m not sure what you can do besides buy inflation-linked bonds, but they are generally priced for a negative real return,” he said.
Gray manages five portfolios, including the £865.3m CF Miton Special Situations fund, the CF Miton Strategic Portfolio and the CF Miton Total Return fund alongside James Sullivan. He runs the CF Miton Worldwide Opportunities fund with Nick Greenwood.
The case for inflation: Jim Leaviss & Stephen Jones
M&G’s Jim Leaviss (pictured) recently warned inflation was more of a threat then investors realise.
The fixed income manager said central banks have let their guard down on inflation and instead turned toward boosting weak economic growth, turning to ever-increasing monetary easing measures in an effort to add a shot of growth to the economy. However, unlike Gray, Leaviss warns these measures could result in a rapid hike in inflation in the near future.
“My outlook for inflation has not changed with the latest readings because of the emphasis I would place, as I have for some time now, on the changing priorities of central bankers, a trend I refer to as ‘central bank regime change’. Instead of trying to hit inflation targets, central banks are now more concerned about weak economic growth. As a result, central banks have stopped combating inflation and are now prioritising economic stimulus measures to reduce unemployment. I would add that governments and central bankers may also view some inflation to be an effective debt-reduction mechanism, something that was successfully used in the developed world after the Second World War. Against this backdrop, I expect inflation to drift higher than markets are currently anticipating" he said.
However, Leaviss, who manages the M&G Global Macro Bond fund says investors can protect themselves through investing in index-linked bonds which he believes represents one of the few areas of the UK government bond market that still offers value.
"In addition to the inflation-linked government bond sector, I believe that inflation-linked bonds issued by companies with a high credit quality offer a good source of protection against rising prices," he added.
"While real yields on index-linked government bonds have fallen to very low levels as a result of strong demand, index-linked corporate bonds provide an additional credit risk premium that comes from lending to companies. In the UK, for example, Tesco and National Grid are among investment grade companies that have issued inflation-linked bonds that I believe can be attractive to hold alongside index-linked government bonds as a means to provide a hedge against rising inflation over the medium to longer term."
Kames Capital’s Stephen Jones admits that there has been a trend toward lower inflation, but says that while inflation figures dipped last month, it is still above the headline level targeted by the Bank of England.
“Despite these good numbers [last week], inflation remains above the level targeted by even the watered down Bank of England inflation rate,” he said.
“The Bank itself forecast some of the improvement, but still, by its own admission, sees inflation ahead of a desired 2 per cent rate for some time to come.”
Leaviss is head of fixed interest at M&G. He manages the firm’s M&G Global Macro Bond, M&G Gilt & Fixed Interest Income and M&G UK Inflation Linked Corporate Bond funds.
Jones is chief investment officer at Kames and manager of the Kames Inflation Linked fund.