Inflation overshoot looms large over profits

Inflation overshoot looms large over profits

UK inflation could overshoot the 2 per cent target and possibly go as high as 5 per cent in the coming year, according to a number of fund managers, who warned some sectors could be squeezed by rising prices.

Last month, UK inflation jumped to its highest level since 2014, prompted by the weaker currency and the rising cost of raw materials such as oil.

According to the Office for National Statistics, consumer price inflation hit 1 per cent in September, a marked increase on the 0.6 per cent reported back in August.

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Last week (21 October), fund managers of the £265m Artemis Monthly Distribution fund warned UK inflation could “easily” reach 5 per cent in the next 12 months.

Stephen Message, who runs Old Mutual’s £224m UK Equity Income fund, said some price inflation is positive, but can also erode pay rises which has a ripple effect.

“This lack of wage inflation is bad news for the consumer, because real wage growth will be negative as the cost of food and energy increases.

As such he is shunning areas directly exposed to consumer spending, such as domestically-focused retail businesses, tour operators, and housebuilders. 

But Mr Message said higher inflation will also be reflected in the bond markets with rising yields, which could benefit financials and life companies. Commodity and mining companies could also stand to benefit from an inflation rise. 

On the 5 per cent inflation prediction, Mr Message said it depends on the currency, which he argued is “notoriously difficult to predict”, but he expected the consumer price index to rise further.

Tony Yarrow, founder of Wise Investments and manager of the £64m TB Wise Income fund, said if inflation did jump to 5 per cent he would expect it to fall back once the one-off effect of sterling passes through. 

“However, it may be that the prolonged era of ultra-low inflation is ending.”

As well as banks, he said commercial property often stands to benefit from rising inflation, because most rental agreements are upwards-only and index-linked.

“I would also expect a stronger environment for the clean energy sector, partly because the underlying price of energy is rising, and partly because roughly half of the sector’s contracts are inflation-proofed.”

Retailers will have to decide whether to pass rising input costs on to their customers, or whether to absorb them themselves.

“The decision will depend on the strength of their franchises, the competitive position, and the level of increases in input costs," Mr Yarrow said. 

“The winners will be companies which either don’t suffer from significantly rising input costs, or can afford to pass them on to customers without losing margins or volumes.”

The point was echoed by Richard Marwood, senior fund manager of the £566m Royal London UK Growth fund, who said a rise in inflation will reveal the businesses that have pricing power.

Lower margin businesses such as supermarkets will have more trouble he said, because they “can’t afford to wear” much of the price increase.