Following a weather-induced contraction of 2.1 per cent in the first quarter of the year, the US economy bounced back to grow by 4 per cent in the second quarter.
The pick-up in growth, which has been matched by a surge in UK economic growth, has led to expectations that wages will soon begin to rise, which bond managers warn is likely to lead to a pick-up in inflation.
Ariel Bezalel, manager of the highly successful Jupiter Strategic Bond fund, said it was clear that there were “wage pressures developing, especially in skilled workers”.
The manager said: “My worry is that it feels that some of the seeds for a pick-up in inflation are being sown.”
In response to these first signs of inflation, such as a rise in wages, Mr Bezalel said he had begun to buy up floating-rate notes for his Strategic Bond fund in an effort to provide some protection if and when inflation does pick up.
Market fears around an imminent spike in inflation were calmed in late July when it was revealed that month-on-month prices in the US grew by only 0.3 per cent in June.
The most recent US jobs figures also dispelled inflation fears a little by showing that unemployment had risen to 6.2 per cent, from 6.1 per cent the previous month.
But Standard Life Investments’ (SLI) Mark Munro said the group’s bond teams were poised to add more inflation protection into their funds, particularly the SLI Strategic Bond fund.
He said: “There could be an upside surprise to wage inflation but that is not what the market is prepared for at all.”
Mr Munro said the specialists on SLI’s rates team were preparing to ramp up their exposure to fixed-income assets that provide protection from inflation, but that it was not the right time just yet.
But Bryn Jones, manager of the Rathbone Strategic Bond fund, said he had already taken steps to protect his fund against inflation coming through.
He said: “The next thing to keep an eye on is wage inflation and we are building a strategy around the rise in inflation in the US.”
Mr Jones said he had been buying up Treasury inflation-protected securities (Tips), the US version of index-linked gilts – government bonds whose value and yield rise along with that of inflation.
Mr Bezalel expressed surprise that more investors were not taking steps to protect against inflation, particularly given recent news emerging that indicated growth in the US and the UK.
He said: “I found it surprising how well the gilt market took the news about a rise in UK inflation. It shows there is complacency in the gilt market and there is a danger of a correction.”
Wages and inflation, by Schroders’ chief economist Keith Wade
Empirical analysis finds little evidence of a causal relationship between wage growth and inflation, but there is a link between the two and it is largely to do with the effect of productivity.
It is unit wage costs (the cost a firm faces to produce one unit of output) – not wages per se – that influence inflation in the near term. When higher real wages are not matched by increased productivity, unit wage costs rise and force businesses to raise prices, or face a squeeze on their profit margins. Consequently, we need to look at the combination of wages and productivity to gauge the effect on inflation through unit wage costs.
Productivity trends have not been encouraging in recent years. There are two key explanations as to why this has occurred. Firstly, it would seem that the boost from the ‘new economy’ as the internet took off in the 1990s has faded and recent developments may not prove as groundbreaking. Secondly, much capital was wasted during the housing boom of the last decade.
Arguably this effect will work its way through and as companies begin to invest again, productivity will pick up, enhanced by the latest new technology. Alternatively, a more cautious banking sector will inhibit the funding of new investment and/or companies will remain risk averse such that capital expenditure does not pick up sufficiently to boost output per worker.
On balance then, the outlook over the next one to two years is for productivity growth to remain relatively subdued, such that a pick-up in wages and worker compensation will result in higher unit labour costs and add to inflationary pressure.
