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M&G bond team still 'bullish' on reflation trade

M&G bond team still 'bullish' on reflation trade

M&G's Andrew Eve has said the 'reflation' theme remains a core focus for the company's bond managers despite recent doubts over the permanence of consumer price growth.

Eve, an investment specialist in M&G's fixed income division, said in a presentation on August 12 the asset manager's inflation-linked bond team was still “bullish” on the reflation trade's prospects.

“It’s not an absolute certainty that we’ll see higher inflation going forward, but certainly in [the past decade] it’s the most bullish we’ve felt on the prospects of more of a medium term reflation scenario,” he said.

Since the development of an effective Covid-19 vaccine was confirmed in November 2020, market participants have been anticipating a rise in inflation driven by economies re-opening, government spending increases and historically low interest rates.

However, despite inflation hitting 2.4 per cent in June - above the Bank of England’s 2 per cent target - the central bank has said it thinks price growth will be “transitory”.

In recent weeks nerves over the durability of the economic rebound have also seen investors shift back to growth stocks, at the expense of the value shares that enjoyed a strong start to the year as part of the reflation theme.

Last month, the BoE said although it expects inflation to rise to nearly 4 per cent in the last quarter of this year, largely due to “developments in energy and other goods prices”, it would then fall back close to the 2 per cent target.

The monetary policy committee did concede rising inflation was now expected to be more pronounced than previously expected, however it added it did not intend to tighten policy “until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2 per cent inflation target sustainably”.

M&G launched its UK Inflation Corporate Bond fund in September 2010. The strategy aims to beat the return of its benchmark, the UK consumer prices index.

As of July 31 the fund was valued at £1.1bn and had returned 2.2 per cent over the past 12 months, above the 1.5 per cent rise in its benchmark but below the 5 per cent average return for its peer group, the Sterling Strategic Bond sector.

It has 38 per cent exposure to synthetic inflation-linked bonds, 23.5 per cent in fixed-rate bonds, and 15 per cent in government inflation-linked bonds.

Running hot

Eve said the central bank had enough room to let inflation run “hot”.

“Governments have a lot of debt and one of the ways to reduce that debt burden in real terms is to allow inflation to run a little bit hot - not double digit but perhaps a little bit higher than we’re used to,” he said.

“Likewise, central banks will want to keep this debt burden affordable for governments."

He added: “If they start hiking interest rates that will make it more expensive for the government to service their debt, so perhaps we’ll see them a bit more hesitant to raise interest rates than we’re used to.”