After the UK’s CPI figures rose slightly in December, fund managers are growing increasingly worried about rising inflation despite it remaining well below the Bank of England’s 2 per cent target.
The Office for National Statistics (ONS) today revealed that consumer prices index (CPI) inflation jumped to 0.6 per cent in December, from 0.3 per cent in November, pushed higher by rising transport and clothes prices.
The US also reported rising inflation figures last week after CPI increased to 0.4 per cent in December from 0.2 per cent in November, largely due to a jump in gas prices.
Close Brothers Asset Management chief investment officer Robert Alster believes the UK is “extremely vulnerable” to a rise in inflation next year, due to soaring government debt and individual purse strings tightening.
However, he added: “Should inflation weaken further, action may need to be taken to stimulate spending and boost the economy; it’s worth remembering that negative interest rates have not been taken off the table as a possible policy tool.”
Laith Khalaf, financial analyst at AJ Bell, said investors shouldn’t draw too many conclusions from the current CPI measures due to how distorted economic activity is.
“While inflation looks well contained, there is increasing concern it could start to be a problem once social restrictions are lifted, as a wave of pent up consumer demand is unleashed,” he explained.
“Central bank stimulus, helicopter money from the government and high levels of cash savings built up during lockdown all support the thesis that the inflation genie may pop out of the bottle in the coming year.”
However, he acknowledged that there are also deflationary pressures in the economy, namely rising unemployment, technological advances and an ageing population.
“While monetarist economic theory tells us that the huge increase in money supply will deliver inflation, this is a dog that didn’t bark after central banks embarked on the QE experiment in the wake of the financial crisis,” Khalaf said.
Indeed, over the last three decades, inflation in the UK has been trending downwards and continued this trend even after the financial crisis of 2008-09.
Inflation over the last 30 years
Source: ONS
“Today however, loose monetary policy is combined with fiscal stimulus and could be turbo charged by the prospect of consumers making up for lost time when social restrictions are eased,” Khalaf argued. “So there is some reason to believe this time really is different.”
The analyst said a “nightmare scenario” for the central bank would be stagflation – where inflation becomes rampant but the economy stalls.
“This would force the bank to choose between letting inflation spiral out of control and keeping the wheels of the economy turning,” he explained.
Anthony Rayner, fund manager at Premier Miton Investors, said that while inflation expectations have increased, they are not yet at excessive levels.
He noted that the recent Democratic sweep of the Congress suggests a larger stimulus package for the US, combined with vaccine rollouts and the OPEC+ output cut, could mean that “the stars are aligned for reflation”.
“Indeed, there is no talk of the spectre of extended lockdowns and maybe markets are looking through that but how far are they looking forward?” he asked.
“Certainly, markets are not looking through the reflationary concept, to inflation. For example, there seems minimal interest in how higher resource prices feed into cost-push inflation.
“We include ourselves in that group that think bonds might struggle this year, particularly developed government bonds, while other safe havens such as gold might do less well if real yields rise.”
Graham Campbell, co-manager of the £90m TB Saracen Global Income and Growth fund, is sceptical as to whether the government can restart the economy while controlling inflation.
He observed that investors have not been considering inflation as a risk and, whilst this position is slowly changing, it is “still not taken as a serious concern”.
According to Campbell , investors have been too used to the “Goldilocks” scenario where growth has been stable and inflation kept in check.
“But what happens after a sharp recession, when governments massively expand money supply, increase debt and hold down interest rates to stimulate growth?” he asked. “Will they be able to restart the economy and will they be able to fine tune the levers to control inflation?
“Those with memories of the 1970s and 1980s will remember how difficult it was for governments to subdue inflation once it got out of the bottle.
“With Democrats now having a clean sweep over the White House, Senate and House of Representatives, it is likely the US will continue to increase public spending, adding to inflationary concerns.”
Florian Ielpo, multi-asset portfolio manager at Unigestion, believes recent developments in inflation drivers on both demand and supply, suggests that inflation is about to make a temporary comeback.
“We believe that this is a material risk and investors must respond,” he said. “This is all the more the case as inflation assets are less favoured than growth assets for the moment. This inflation comeback requires preparation.
“The risk for 2021 is not really on the recessionary side in our view, but rather on the side of the natural consequence of rapidly accelerating economic activity: inflation. The recognition of a growing inflation risk is the most important change in our investment policy in recent months.”
As a result, Unigestion is allocating towards both growth assets and inflation assets, with a preference for inflation breakevens as well as energy and industrial metals.
BlackRock’s Investment Institute have also said that the Democratic majority in Congress could accelerate its ‘new nominal’ theme in 2021.
It expects significant fiscal support coming from the Democrats to push inflation higher over time, but that the Federal Reserve will keep the rise in US Treasury yields in check.
When Treasury yields breached 1 per cent for the first time since last March, driven by increases in both inflation expectations and real yields, the institute believes this suggests “markets are likely to test the Fed’s resolve to lean against any excessive climb in nominal yields”.
BlackRock also expects greater fiscal spending to be funded through increased deficits rather than higher taxes and a strong vaccine-led restart later in the year.
“All this reinforces our view on growth, rates and inflation, and underpins our preference for inflation-protected securities over nominal US Treasuries,” it finished.