The decline in the rate of UK inflation over recent months has certainly proved a welcome respite for investors and eased the pressure on policymakers to take action. However, as welcome as this relief may be, we see this as only a temporary situation, before a return to a somewhat inevitable upward inflation trajectory, over the medium term.
If we look back to as recently as September 2011, with CPI and RPI inflation having reached 5.2% and 5.6% respectively, the sense of concern amongst investors, particularly bond market investors, was almost tangible. Hovering around levels some 2-3% higher than the Bank of England’s (BoE) 2% CPI inflation target, investors were becoming increasingly worried that inflation was spiralling out of control, seriously impacting prospective investment returns. With nominal gilts, for example, offering very depressed yields (10-year gilt yields touching lows of 1.996% on 23 December 2011), the prospect of inflation at 5% levels raised the unsavoury prospect of real returns for investors in the region of -3%.
Fast forward to today, just six months on, and with inflation back down to more ‘reasonable’ levels (3.4% and 3.7%, for February CPI and RPI respectively), it appears that those earlier concerns have been largely dismissed. Despite remaining some way above the BoE’s target level, the inflation issue has all but disappeared from the current investment agenda. However, the risk here is that, with the spotlight removed, investors become complacent and, as such, are caught unprepared for what we see as an inevitable re-emergence of inflation over the medium term.
Inflationary Central Bank Policy
You only need to look as far as the policies of the world’s major central banks to understand why such an expected re-emergence of inflationary pressure is likely. The main concern over recent years of the BoE, the US Federal Reserve and the European Central Bank, has been to stimulate growth and to avoid a dreaded deflationary environment. To this end, all three central banks have in place ultra low interest rates and very accommodative monetary policy regimes. In addition, all three have responded to the post-crisis challenges with vast-scale money creation, i.e. each has printed more money, pumping huge amounts of liquidity into the system via Quantitative Easing (QE) policies. Longer-term, such massive stimulus can only prove inflationary. However, what is perhaps most significant is the fact that the three central banks in question all currently have a clear and visible inflationary bias. They would all rather deal with inflation than deflation, and, as such, our expectation for renewed inflationary pressure over the medium-term almost seems entrenched in policy. With this in mind, investors should consider investing in the only true hedge against the value-eroding effects of inflation - inflation-linked bonds.
Since first launched (in 1981 in the UK), inflation-linked bonds have rapidly gained prominence as a key investment asset class. As countries continue to step up efforts to fight inflation, particularly in the emerging world, and central banks and investors alike look to protect their purchasing power, so the inflation-linked bond market should continue to grow in size and importance, providing investors with enhanced portfolio diversification and yield.
AXA Investment Mangers: the inflation-linked experts
We believe AXA Investment Managers (AXA IM) stands as a true pioneer in the area of inflation-linked investment, being one of the first asset managers to launch a stand-alone, inflation linked bond fund. With experience spanning some 25 years, our team of investment experts bring significant knowledge, experience and insight to managing flagship Global, Euro and Sterling inflation-linked portfolios.
Further proof of AXA IM’s expertise and leadership in this asset class comes in the form of our innovative Redex share class offer. Given that the longer-duration nature of inflation-linked bonds also brings increased sensitivity to interest rate movements, the Redex share class provides investors with exposure to our managers’ key investment strategies and specific drivers of outperformance (country inflation arbitrage, breakeven strategies, curve positioning etc.), while, at the same time, minimising the exposure to the negative effects of interest rate rises. In this way, AXA Investment Managers can offer an appropriate solution, whatever your inflation-related investment problem.
To find out more about how AXA IM can help your clients protect their investment from the potentially value-eroding impact of inflation, contact us at http://adviser.axa-im.co.uk or call us on 0845 766 0184.
David Dyer is Inflation-Linked Bond Fund Manager, AXA Fixed Income
