News & analysis INFLATION: A STICKY PROBLEM
Inflation is on the decline, but the risk it poses is not, says Andrew Holt.
I feel like Morrissey from The Smiths singing, Stop me if you have heard this one before, but: inflation is still a problem. I can cite as my star witness none other than US Federal Reserve chair Jay Powell. “It remains too high,” he confessed of inflation at the Fed’s annual symposium at Jackson Hole in August. And when Powell speaks in such terms, it indicates something serious is happening.
This is despite US inflation standing at 3.2% in August. Then there was, of course, the unexpected fall in UK headline Con- sumer Prices Index (CPI) inflation. It slipped from 6.8% to 6.7% during August, versus the Bank of England’s consensus of 7.1%. More importantly though is core CPI inflation, which recorded a sharper fall. It slid from 6.9% to 6.2%, despite the 6.8% con- sensus, while services inflation declined from 7.4% to 6.8%, smashing the Bank’s 7.2% expectation. The latter is key when the Bank judges the persistence of domestic price pressures. It led to the Bank ending a run of 14 straight interest rate hikes in September. With the narrative being that inflation is stabilising.
As part of this narrative, the Bank said it expects inflation to fall to around 5% by the end of this year. It then expects the cost of goods and services to keep falling in 2024 before reaching the Bank’s 2% target in the first half of 2025.
Longer-term problems But Richard Tomlinson, chief investment officer at Local Pen- sions Partnership Investments, says this is unlikely to play out over the longer term. “In the short-term, inflation is coming down.
“It is coming under control, with rate hikes doing their job. But it will be harder to get long-term inflation back to what we were used to, say at 2%.
“Long-term inflation will be higher due to geopolitics, supply chains, demographics – all those things – structural factors,” he added.
A point shared by Richard Bullock, Newton Investment Man- agement’s senior research analyst in global macro-geopolitics. “It’s too early for many Western countries to declare victory over inflation,” he said. “The challenge is not so much in head- line inflation, which will come down with food and energy base effects, but in core inflation, in which costs of labour and ser- vices remain elevated.”
There is within this something of a new reality, added Bullock. One that “in labour markets is a function of demographics –
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retiring baby boomers – and geopolitics: more protectionism and lower labour mobility. Geopolitics and de-globalisation also mean that inflation is likely to remain sticky and higher”.
Taming inflation Shweta Singh, chief economist at Cardano, the investment group behind Now Pensions, is also full of warnings about the inflationary threat. “Even if inflation is now tamed for this cycle – we don’t think that it is – wages continue to grow at a brisk rate and well above the level consistent with the Bank of England’s 2% inflation target,” he said. “Underlying inflation pressures remain sticky and are likely to stay elevated over the next 12 months,” he added. Sebastian Vismara, an economist at BNY Mellon Investment Management, is also concerned about the sticky nature of inflation. “UK wage growth data keeps surprising to the upside relative than the Bank’s forecasts, and core inflation remains high and has been sticky, at least until recently. Energy prices have surged in the past few months and could increase further.” Vismara makes the valid point that the global economy has been weakening since the last quarter, but not by enough to create much slack.
“In other words, there remains the risk that this easing in core inflation proves to be another false dawn, and that the fall stalls or even reverses in the coming months.” And he added: “The Bank is likely to want to see broader disin- flation trends in play before ending its hiking cycle.” The Paris-based Organisation for Economic Co-operation and Development (OECD) has also lined up to give something of a warning shot across the Bank’s forecasts. The OECD said in its interim economic outlook published in September that it expected UK inflation to average 7.2% during 2023 – significantly higher than the Bank’s expectations. This is also a rise on the OECD’s 6.9% forecast in June, which sug- gests that things are not under control in the way the Bank has indicated when it comes to inflation.
Collateral damage And Blackrock has given an even starker warning. It noted in one of its outlooks that bringing inflation down to the Bank’s target entails crushing demand to meet constrained supply, meaning significant economic damage – a potential more wor- rying outlook than the spectre of inflation itself. Given the situation, it is not surprising that 70% of pension funds manage their assets to an inflation-plus benchmark, according to investment boutique Alphareal. It all adds up to a bleaker inflationary picture than is being pre- sented. Investors need to therefore proceed with caution.
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