The Big Picture THE BIG PICTURE: INFLATION OUTLOOK: DIVERGING SCENARIOS
UK CPI INFLATION 10%
1% 2% 3% 4% 5% 6% 7% 8% 9%
0%
Source: Office for National Statistics
With ever increasing levels of cash pumped into markets, there is hardly a forecasting figure that divides economists as much right now as the inflation outlook. Some fear rising prices, others deflation. How could these diverging scenarios affect pension funds? Mona Dohle reports.
When it comes to predicting the future, economists do not have a great track record. “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today,” Canadian psychologist Laurence Peter once joked. Evidence of that is found in economists’ track record in predict- ing inflation levels. Back in 2008, when central banks injected what then seemed to be unprecedented levels of cash into the economy, most economists warned that this could lead to higher inflation. Fast forward 12 years and even more money is being pumped into the economy, but the primary concern now is that price levels might be falling. This appears to be justified as between April and May, UK CPI figures plummeted to 0.9%, down from 1.5% a month earlier. Driving the fall in price levels is the unique set of circumstances generated by the Covid-19 pandemic, most importantly the
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sharp drop in oil prices, which is pushing down CPI figures, and many retailers selling stock at discounted rates due to forced shop closures. Going forward, wage disinflation is also likely to aggravate the picture.
The effects for pension schemes are mixed at best. On the assets side, falling price levels increase the total value of bonds, which could be good news for DB schemes on a long-term tra- jectory to increase their fixed income exposure. However, these benefits are likely to be offset by the fact that lower price levels make central bank rate hikes less likely, further aggravating the downward pressures on bond yields and in turn on DB scheme liabilities. Indeed, shortly after the May CPI figures were announced, UK gilts traded at negative yields for the first time. Having said that, the prospect of inflation rising over the longer term should not be written off just yet, some economists argue. For starters, rising debt levels mean that higher inflation might be considered politically desirable. Moreover, unlike 12 years ago, when liquidity measures were targeted at the financial industry, cash interventions are now directly aimed at the real economy, which could drive up price levels. Added to that are manufacturing supply side challenges aggravated by Covid-19 and Brexit kicking in by the end of this year, which could fur- ther drive up price levels.
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