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UK inflation surges above target: What does this mean for investors?

21 March 2017

Investment professionals discuss this morning’s news that CPI data leapt to 2.3 per cent in February, exceeding the Bank of England’s target for the first time in more than three years.

By Lauren Mason,

Senior reporter, FE Trustnet

UK inflation jumped from 1.8 per cent to 2.3 per cent during February, according to data from the Office for National Statistics, beating the Bank of England’s target for the first time since November 2013.

Not only has inflation data (measured using the new CPIH headline figure, which includes owner occupier housing costs) surged past the central bank’s 2 per cent target, it has also exceeded consensus expectations of 2.1 per cent.

The main factors contributing to the sudden boost were food and fuel price rises, the former of which has fallen consistently over the last two and-a-half years up until last month, when prices rose by 0.3 per cent.

Sterling has reacted positively to the news, with the currency rising to three-week highs against the dollar shortly after the data was released.

Richard Theo (pictured), CEO of Wealthify, warns that inflation is the “grim reaper” of cash savings and, given it has risen above target, now looks to be “more deadly than ever”.

“We are suffering a silent savings crisis,” he warned. “Rising inflation is another blow to Britons who already suffer rock-bottom interest rates and minimal returns from their cash savings.

“When inflation sat at 1.8 per cent it was wiping £7.98bn from Britain’s £700bn cash savings annually. With no movement from the MPC on base rate, inflation will continue to erode billions of pounds every single year.

“With inflation at its highest level since 2013, the cash savings account has become the finance equivalent of the chocolate teapot. Savers need to act now and find alternative ways to grow their money.”

With this in mind, where should investors be putting their money to get the most out of their savings?

A number of industry commentators have questioned whether this data will lead to a rise in UK interest rates, which could have a negative impact on government bonds and so-called ‘bond proxy’ stocks.

Performance of indices over 1yr

 

Source: FE Analytics

Neil Wilson, senior analyst at ETX Capital, said: “This data puts more pressure on the Bank of England to consider a rate rise. The MPC [Monetary Policy Committee] said last week it would ‘take relatively little further upside news on the prospects for activity or inflation’ to warrant tightening.

“It has also said it has limited tolerance for inflation to overshoot, which it is now doing. At 2.3 per cent there will be stronger voices on the MPC wanting a hike. Gauges of activity in the economy continue to be strong.

“But the picture is incredibly complex. We don’t know where Brexit is taking us. There are signs that the consumer spending is slowing. Inflation is now at the level of wage growth, and rising, meaning we can expect the pressure on household spending to deteriorate. We are now about to experience falling real wages. Therefore the market may be over-egging the chances of a rate rise.”


Ben Brettell, senior economist at Hargreaves Lansdown, says those who are hoping for higher interest rates because of rising inflation data could be in for a long wait.

“The most recent Bank of England minutes note that to attempt to offset the effect of weaker sterling on inflation would come at a cost of higher unemployment,” he pointed out.  “As such I expect the Bank to look through these higher numbers and keep bank rate at 0.25 per cent for the remainder of this year.

“Meanwhile inflation at 2.3 per cent is now higher than the growth in average earnings (2.2 per cent), meaning real pay is officially shrinking. The interplay between these two numbers will be closely watched over the coming months.”

Considering the UK’s dependence on consumer spending, many industry commentators fear this could spell bad news for the domestic economy.

James Klempster (pictured), head of investment management at Momentum UK, said: “Given wage growth slowed down significantly during this period from 2.6 per cent to 2.3 per cent, this is a serious threat to living standards.

“The next step is to see how much of this increase in prices can be included in wage negotiation, otherwise we will start to see consumers feeling the pinch in their pockets.”

Russ Mould, investment director at AJ Bell, says the fact inflation will start to wipe out any advance people are seeing in their wages, combined with the fact most of the inflationary pressure has been caused by the weak pound’s impact on the cost of imported goods, agrees with the aforementioned commentators that an imminent rate rise is unlikely.

“The Bank of England and OBR see inflation peaking at 2.8 per cent and it will be wary of making an increase while wages are falling and inflation is increasing, so we are unlikely to see any knee jerk reactions from Mark Carney and his team,” he said.

Viktor Nossek, director of research at WisdomTree, says that inflation itself is unlikely to continue rallying from here given the various other factors weighing on the UK economy.

While he says the latest figures have been caused by ‘bad’ inflation from energy and food as well as the pound’s sustained weakness since Brexit, he urges investors not to make rash decisions.

“The reading, which now includes a reading of house price inflation, is higher than expected. However, there is no need for investors or consumers to panic about runaway prices,” the director of research said.


“Inflation is not returning to the highs seen during the 1990s – indeed the coming months are likely to represent a peak for CPI if energy prices continue to trend lower, and with signs that economic activity could weaken in the near-term amid a potential slowdown in the UK’s dominant services sector.”

However, Darius McDermott (pictured), managing director of Chelsea Financial Services, believes inflation could continue to rise to between 3 and 4 per cent over the coming months as ongoing Brexit negotiations are likely to further weigh on the strength of sterling.

As such, he warns that cash and bonds are the two asset classes likely to be hit hardest, given that rising inflation will eat away at the valuation of uninvested wealth and fixed coupons.

For those that want to retain exposure to fixed income assets though, he says higher-yielding bonds funds – such as Aviva Investors High Yield Bond and Rathbone Ethical Bond – are better equipped to cushion any further inflationary blows.

In terms of equities, he says there are some companies that do better in inflationary environments, such as cash rich firms and those with pricing power.

“Infrastructure is also a good bet, as many of the underlying projects can have prices linked to inflation. You could consider First State Global Listed Infrastructure or VT UK Infrastructure Income,” he said.

“Energy companies also tend to do well. While they are heavily regulated, the regulator will allow them to raise prices in line with inflation. So the likes of utilities stocks or even gas companies may be attractive, or a fund like Guinness Global Energy.

“More generalist UK equity funds that have a nice level of yield include Artemis Income and Fidelity Enhanced Income.”

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