News that the UK consumer prices index (CPI) rate of inflation had risen to 2.7 per cent, outstripping wage growth, has raised concerns about a cost of living crisis as the UK prepares for a general election in June.
The 12-month CPI rate climbed to 2.7 per cent in April up from 2.3 per cent, while wage growth increased by 2.1 per cent.
CPI % change since 1989
Source: Office for National Statistics
Ketan Patel, fund manager at EdenTree Investment Management, notes that the latest inflation figure is the highest since 2013 and was boosted by an early Easter and rising airfares.
He said: “The upward trajectory of inflation, especially post-Brexit, will ensure the debate on living standards will be at the top of the political agenda in the run up to the general election in June.
“However, more worrying was the rise in clothing and electricity prices, which will lead to further pressure on disposable incomes, more so in an environment of anaemic wage growth.
“Further out, the level of sterling will be a key determinant on consumer prices, a sentiment echoed by the Bank of England last week, which warned on rising inflation and falling real wages.”
Earlier this month, Bank of England governor Mark Carney said inflation in the UK continued to be influenced by the response of households, companies and markets to the proposed departure from the EU.
Carney said CPI inflation had risen above target due to the depreciation of sterling and was expected to peak a little under 3 per cent by the fourth quarter of the year.
“The projected inflation overshoot entirely reflects the effects on import prices of the fall in sterling since late November 2015—a depreciation caused by market expectations of a material adjustment to the UK’s medium-term prospects as it leaves the EU,” he noted.
Indeed, Scott Bowman, UK economist at consultancy Capital Economics, says inflation should increase further in coming months “as the peak impact of the fall in the pound approaches and utility companies complete their price hikes”.
He noted: “We think that CPI inflation will reach a little over 3 per cent before the end of the year. However, there are few signs of domestic cost pressures building.
“And with the fall back in producer input price inflation over each of the past three months suggesting that the exchange rate pass through will be less protracted than usual, we think that inflation will drift back towards the target thereafter and the squeeze on real wages won’t be too severe.”
May 2017 projections for CPI based on market interest rate expectations
Source: Bank of England
Tommaso Mancuso, head of multi asset at Hermes Investment Management, says while inflation had remained above the Bank of England’s target rate of 2 per cent for the third consecutive month, he believed it could fall in the months ahead.
He said: “Following the release, the markets expectation of future inflation declined, as indicated by inflation breakevens. This would suggest the market sees inflation as having peaked and expects it to taper from here.
“Nonetheless, Brexit uncertainty, heightened residual liquidity generated by quantitative easing, the Bank of England’s inclination to ignore a cost-led inflation-target overshoot and renewed interest in fiscal policies are all factors that could keep inflation higher and for longer than currently anticipated. Therefore, we still believe it is prudent to carry inflation protection in investment portfolios."
The prospect of higher inflation has prompted several managers to act to protect their portfolios and take advantage of any opportunities that may arise.
Mike Pinggera, manager of the Sanlam FOUR Multi-Strategy fund, says the backdrop of political uncertainty, equity indices at or near record highs and low bond yields have created a “challenging” environment for investors.
He said: “Bonds will deliver a low but predictable level of income, yet will struggle to keep pace with inflation over the longer term.
“Equities will deliver a variable near-term income and have historically offered some inflation protection, but volatility is likely to be high.”
Pinggera added: “My preferred route is to invest in alternative assets – such as infrastructure, renewable energy and specialist property, including distribution centres and student accommodation – which provide a stable income stream with inflation linkage.
“While some market participants have viewed these areas of the market as expensive, they continue to perform extremely well; and where else can you get 4 per cent yields with inflation linkage? Real assets should continue to be an attractive home for investors in this environment.”
Vince Childers, senior vice president and real assets portfolio manager at investment manager Cohen & Steers, also says new market and economic conditions favour real assets.
He said: “Many investors have come to rely on asset allocations modelled on the old economic order: decades of globalisation, falling inflation, slowing economic growth and declining interest rates.
“We believe the old order is transitioning and that the global macro environment is now clearly moving in favour of real assets.”
Childers added: “As the market transitions away from low growth and low inflation, we believe investors should consider increasing allocations to real assets, strengthening a portfolio's ability to defend against inflation risk while providing the potential for attractive, low-correlated returns.”