Inflation could stay much higher for longer due to the “canned heat” of loose monetary and fiscal policy and a new attitude from central banks, according to a number of investors.
Konstantinos Venetis, director of global macro at consultancy firm TS Lombard, said there was considerable downward pressure
But he believes the pressures on the banking system in the US, which would be exacerbated by a recession, mean central bank focus, which has so far been entirely focused on reducing inflation, could switch to being more worried about achieving financial stability.
If that shift in focus happens then the likelihood is interest rate rises would either be paused early to preserve liquidity in the financial system and reduce debt defaults or interest rate cuts could be brought forward.
Either scenario would have a material impact on inflation expectations in the economy, and potentially drive inflation higher.
He describes this as just one of the potential range of economic outcomes, and adds that uncertainty in the banking system also increases the chances of a recession as banks reining in lending has much the same effect as higher interest rates, but likely happens at a faster pace.
David Jane, multi-asset fund manager at Premier Miton, is another who sees potential for inflation to stay higher for longer.
He says: “Historically, inflation at current levels has rarely been a purely transitory problem, once prices rise by a certain degree they tend to continue to rise rapidly for a period of years. This is a dual consequence of business and consumer behaviour changing to adjust to rising prices and government actions to mitigate inflation impacting on certain targeted groups.
Pressure points
"At present workers appear to have a very strong negotiating position, as current levels of demand and a reducing labour force mean that labour shortages persist in most western economies. This means that wages are growing strongly, although in many cases not as fast as CPI inflation.
"This will only change in the case that the economy slows materially, to the point that there is excess labour again. Basically, unemployment will rise enough to ease wage cost inflation in the event of a recession.
"Despite rising prices, consumers balance sheets are still strong, at least in the US, where most mortgages are long term and on fixed rates. One possible, disinflationary, impact might be a material fall in house prices and rents, as higher interest rates bite into house prices.”
Despite rising prices, consumers balance sheets are still strong, at least in the US, where most mortgages are long term and on fixed rates. One possible, disinflationary, impact might be a material fall in house prices and rents, as higher interest rates bite into house prices.”Davud Jane, Premier Miton The key role of consumer and business sentiment in the trajectory of inflation was recently highlighted by the Bank of England chief economist Huw Pill who, in a speech in Geneva, said monetary policy actions on their own cannot control inflation.
His view is that, for example, while government policies shielded consumers from some of the effects of higher energy costs, this policy action actually contributes to inflation as the higher price is still being paid, and the existence of the higher price in the economy may mean others are able to increase the price of their goods and services.
He adds that as long as there are labour shortages, and some sectors of the economy where companies have an outsized share of the market in which they operate, price and wage costs can keep rising regardless of central bank action.
Jane’s view is that while the headline effects of last year’s sharp rise in energy prices will fall out of the data later this year, and so reduce the headline rate of inflation, he believes cost of living supports create “canned heat” in the economy, as they increase the level of spending power for individuals, but do not address the route causes of the higher prices, and so do not have a deflationary impact.
He says that while an economic slowdown is likely coming, he doesn’t believe it will be of a magnitude to reduce inflation as he feels consumers and businesses continue to have sufficient savings.
Venetis says global economic data actually points to an uptick in economic demand of late, but that while the input costs associated with manufacturing have been falling, inflationary pressures have transferred to the services part of the economy, and away from manufactured goods.
This matters because the factors which determine service sector inflation, including wage costs, could be more sticky than those associated with manufacturing, because the manufacturing inflation was influenced by damaged supply chains resulting from the pandemic and those can ease, as economies re-open, but the factors causing the services sector inflation are less transitory.
Investment implications
Jane says one of the outcomes of the current economic conditions is that there are more opportunities for income investors, with both bonds and many areas of the equity market now offering what he views as attractive yields.
He says the key to the attractiveness of equity yields right now is that its not just the economically sensitive areas of the market that offer a decent income.
Jane says: “You buy cyclicals, defensives, industrials and even some growth areas and as an income manager you don’t have to just buy yields you obviously have plenty of growth also. Mind you next decades growth is likely to be primarily hard asset growth.”
Julie Dickson, investment director at Capital Group, believes the next phase of the market will be characterised by investors placing a higher priority on companies that pay dividends, which she feels has not always been the case over the past decade.
Mattias Born, head of equities at Berenberg, is another who feels there has been a change in market sentiment, with a greater desire among investors to own assets which have visible earnings today, rather than stocks which are more about future potential.
But he is quite cautious on the outlook for the global economy and so is sticking with the more defensive equity stocks in areas such as pharmaceuticals.
david.thorpe@ft.com
