Advisers, analysts and fund managers have raised concerns the country’s debt levels are simply too high to be repaid through tax rises, with politically acceptable shake-ups merely scraping the surface of the increased balance owed.
With previous periods of high inflation often occurring during or after recessions, a hefty rise in inflation would not necessarily surprise investors and would, in fact, mirror the past.
Steve Russell, co-manager of the Ruffer Total Return fund, said: “The coronavirus pandemic has hit public finances like a war and across the world governments have scrambled to offset the economic impact.
“Such debt levels are simply too big to be repaid through tax rises. Inflation – not growth, austerity or taxation – will have to do the heavy lifting, which poses the greatest risk to savers today.”
Steve Carlson, chartered financial planner at Carlson Wealth Management, agreed. He said: “We can’t repay the debt through taxation; it will need to be inflated away.
“There is also going to be pressure worldwide to keep interest low as borrowing levels are so high, so that could lead to stagflation – high inflation and low interest rates.”
According to Adrian Lowcock, head of personal investing at Willis Owen, there was “huge potential” for high levels of inflation over the next five years, while Tom Becket, chief investment officer at Psigma, said he was preparing for a period of rising inflation, which he had named the ‘turbulent 20s’.
Mr Becket added: “‘Recency bias’ across consumers and economists alike has contributed towards a view that such trends will persist, but there is now a chance that there are a number of factors that could lead to a rise in inflation in the coming decade.”
The great spend
The UK’s debt hit £2tn for the first time earlier this year as the government shed cash in its attempts to save jobs and businesses amid the coronavirus crisis.
Official figures from the Office of National Statistics showed public sector debt stood at £2,060bn at the end of September – around 103 per cent of gross domestic product.
In July, the UK’s national debt dwarfed the size of the economy for the first time since 1961 and September’s 103 per cent ratio was the highest since the early 60s, too.
The pandemic has had an impact on public sector borrowing that is unprecedented in peacetime.
Provisional estimates indicate the £208.5bn borrowed in the first half of the current financial year (April to September 2020) was nearly four times the £54.5bn borrowed in the whole of the last full financial year.
This week yet more measures were announced to support businesses and workers during the pandemic, including an extension of the furlough scheme to March.
Mr Russell said: “In the UK, increasing everyone’s income tax by 1 per cent would only raise an estimated £5bn to £6bn, while a 1 per cent rise in VAT would raise about £7bn.
“Neither of those would make any noticeable dent in this mountain of debt, and even doing both it would still take 150 years to pay down.”
With the UK braced for another month of lockdown, and the government pledging to protect most ‘viable’ jobs, it is unlikely the monthly borrowing figures are going to dwindle any time soon.
Where to turn
As inflation erodes the value of cash sitting in the bank, particularly when interest rates are at historic lows, experts encouraged investors to avoid “large cash piles” and instead turn to gold and equities.
Jason Hollands, managing director at Tilney, said: “Investors do need to prepare for this. Firstly, by not holding excessive amounts of cash, the real value of which will get eroded by inflation.
“Secondly, you need to own assets that can provide a degree of inflation protection such as index-linked bonds, real assets like gold, and equities.”
Meanwhile, Ruffer said it had protected its portfolios with inflation-linked bonds and gold making up more than 40 per cent of the assets, while Mr Becket said Psigma had increased exposure to both the debt and equity of companies for whom a backdrop of rising prices would be an advantage.
Scott Gallacher, director at Rowley Turton, agreed it was worth preparing for inflation but claimed that a well-diversified portfolio should already be set for such an outcome.
He said: “Investors are wise to be aware of the risk but I suggest that a well-diversified investment portfolio offers the best protection as real assets, such as property and equities, are generally regarded as being a good protection against inflation.”
For Willis Owen’s Mr Lowcock, it was important investors prepared for a “range of possibilities” going forward as inflation was “by no means guaranteed” and “could still take a few years to materialise”.
He said: “Equities have historically done well when inflation is present but generally if it is mild inflation, say 2 to 6 per cent.
Higher, and things get complicated with some companies struggling to keep and unable to pass on the higher prices.
“Bonds are not great for inflation, although some areas such as high yield are much less sensitive as are short-duration bonds. Government gilts with low yields look unattractive and inflation-linked bonds just don’t offer much protection.
“Gold has a history of offering inflation protection and should continue to do so. It is more attractive in the current climate of low and negative interest rates as well.”
imogen.tew@ft.com
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