Today’s CPI figures show the Bank of England’s inflation target has been beaten four times in a row, and industry commentators have very mixed views as to what this will mean for investors.
Today’s figures from the Office for National Statistics (ONS) show CPI inflation reached 2.9 per cent in May compared to 2.7 per cent in April. RPI inflation also surprised to the upside, having risen from 3.5 per cent to 3.7 per cent over the period.
Given these higher-than-expected figures, some investment professionals now warn that a real wage squeeze could have negative ramifications for markets.
They believe monetary tightening could also be implemented by the Bank of England (BoE) sooner than expected if inflation continues to rise.
On the other hand, some investors argued that there is little cause for concern when it comes to tightening as retail sales continue to decelerate and Brexit negotiations remain a large unknown. As such, they believe it is highly unlikely that inflationary pressure will continue to build.
Viktor Nossek, director of research at WisdomTree in Europe, pointed out that rising inflation figures were caused by the costs of goods and services rather than imports.
“With uncertainty over the political situation in the UK already impacting Brexit negotiations, the pound has come under pressure once more and is now at its lowest level for months,” he said.
Performance of sterling vs the US dollar over 6months
Source: FE Analytics
"It's expected to remain volatile and succumb to more downward pressure, providing yet another unwelcoming rise to import cost-induced inflationary pressures for consumers.
"Combined with indications of economic activity weakening, as evidenced by both actual GDP and retail sales decelerating markedly against a backdrop of weakening business sentiment, the BoE is unlikely to tighten soon. It's clearing the path for inflation to hit 3 per cent.”
Ben Lord, manager of the M&G UK Inflation Linked Corporate Bond fund, said currency is the key issue for UK inflation, and calls into question whether upward revisions to inflation this year require upwards revisions for peak inflation, which is expected to be reached between the end of the year and the start of 2018.
As with Nossek, he said it is likely that the peak will be 3 per cent in CPI and 4 per cent in real piece inflation terms.
“The direction the pound takes from here will have significant implications for inflation in 2018,” the manager explained. “On the one hand, as the market started to anticipate a strong Conservative majority the pound appreciated rapidly. And since the outcome of the hung parliament, the pound has fallen back to pre-general election levels.
“Ultimately caution is required at this juncture, as the moves have been somewhat counterintuitive.”
When it comes to the triggering of a monetary policy response, he agreed that fiscal tightening remains unlikely at this juncture.
“With so little evidence of domestic inflation pressures, and with most inflation coming from ‘transient’ and exogenous forces, Mark Carney will look through CPI at 3 per cent, 4 per cent and even 5 per cent perhaps.
“In fact, if Brexit negotiations commence poorly, and if the government can’t get anything done without a workable majority and now with a viable and sizeable opposition, I would still argue that Carney’s last move at the helm may be in the looser direction.”
Nathan Sweeney, senior investment manager at Architas, said inflation is likely to have reached its peak. Even though it has now hit its highest level since June 2013, he believes most of the inflationary pressure in the system has been washed through.
“Coupled with the uncertainty caused by the recent general election result we don’t expect these inflation figures to cause the Monetary Policy Committee to introduce a shock rate rise this week,” he reasoned.
“Overall the UK stock market has seen a strong run since the referendum vote driven by a weaker pound and rebound in commodity stocks. Much of that is now factored into markets and after such a strong rally valuations look expensive, especially given the inflationary impact on consumer confidence.
Performance of index since EU referendum
Source: FE Analytics
“As such we are maintaining our underweight to UK equities and increasing exposure to defensive large caps using the Fidelity Money Builder Dividend fund at the expense of cyclicals and mid-cap stocks.”
When it comes to inflation and its impact on consumer confidence, Fidelity International’s Maike Currie said the rising prices combined with lacklustre earnings growth means real income is being squeezed, which has led to UK consumer spending falling for the first time in nearly four years.
“This is bad news for an economy which relies on confident consumers spending on goods and services - already we are seeing signs of a stagnating economy as confidence among companies and consumers falter. Election result paralysis will only add to the UK economy’s woes,” she warned.
“Inflation never seems like a problem until suddenly it is and while it may be good news for borrowers, as it erodes the value of their debts, it has detrimental implications for savers, investors and retirees, chipping away at the value of future interest and dividend payments and eroding the worth of your capital pot.
“Once pricing pressures become entrenched, consumers feel the pain, businesses don’t invest and the stock market gets worried.”
To shield against inflation Currie said real assets should fare well. Examples of funds in this space that could present themselves as good options, according to the investment director for personal investing, include Investec Global Gold or BlackRock Global Property Securities Equity Tracker.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Michael Baxter, economics commentator for The Share Centre, warned the UK is suffering a “double blow” in that inflation is rising due to higher commodity prices – not dissimilar to what is happening in the US and the Eurozone – but has been put under extra pressure by the fall in sterling.
“The commodity effect is a one-off, and indeed the oil price has settled down at a level that is low compared to a few years ago. We are already seeing signs of this effect reversing in the US and euro area,” he pointed out.
“But, while the currency effect will not last forever, the experience of the post-2008 period shows that it can take several years before a fall in sterling stops influencing the inflation rate.
“However, the falls in sterling, especially against the euro, have not been as great as post-2008, and until recently, the drop in sterling after the Brexit vote had been partially reversed.”
That said, Baxter said there could be another currency-related jump in inflation a few months down the line if this fall in currency doesn’t reverse.
“For now, the big hit arising from the jump in inflation will be on real earnings. The rise in the cost of living is beginning to hurt consumers – which will be negative for companies that target the domestic economy,” he added.