Cover story – Inflation
For nearly a year inflation has been a spectre haunting the global economy. The question is: how afraid should institutional investors be?
The initial view identified inflation as being transitory. Once the global economy started moving again, when the worst of Covid appeared to be behind us, and logjams in various supply chains start to clear, the outlook would be rosy and inflation would diminish as a threat.
This could well be true. Although things have not turned out like that as inflation has kept rising. By the end of 2021, the consumer price index inflation rate hit 5.1% – a rate the Bank of England expected it to reach by the spring of this year. In its November Monetary Policy Report, the Bank stuck to its transi- tory inflationary outlook: “We expect these high rates of infla- tion to be temporary.”
This view was endorsed by the December report. “Bank staff expect inflation to remain around 5% through the majority of the winter period, and to peak at around 6% in April 2022, with that further increase accounted for predominantly by the lagged impact on utility bills of developments in wholesale gas prices,” the report stated. This view is not shared universally. Jari Stehn, chief European economist at Goldman Sachs, says inflation will peak at 7% in the UK during April. That said, he does think it will slow from that point onwards.
The inflationary picture has many nervous commentators ask- ing: how long is a transitory phase before it becomes baked in as an actual trend? Many economists have been arguing over, and redefining, the true meaning of transitory. What is clear is the picture thus far has had a financial cost. According to con- sultant Lane Clark & Peacock, inflation has already weakened UK corporate balance sheets by around £20bn due to the impact on pension scheme valuations – and this could turn much worse if it becomes more than a transitory blip.
Defining transition How much of an inflationary abyss are we staring into in 2022? Much centres on the transitory analysis. If you accept that the inflation rate is transitory, then it could be a case of jog on, noth- ing to see here. Richard Williams, chief investment officer at Railpen, says: “Of course, it depends on how one defines ‘tran- sitory’. But from Easter 2022, it’s likely that annual inflation rates will fall from their current levels, and perhaps markedly.” On this scenario inflation could be on the turn. “Headline inflation rates are probably at their peak,” Williams says. “Yes, there’s a plausible scenario that resembles the 1970s, but it is more likely that inflation rates will fall. However, I expect most of them to eventually settle in a range above those that existed pre-Covid. And perhaps the subsequent volatility of inflation will be greater.”
20 | portfolio institutional | February 2022 | issue 110
At the best of times, inflation forecasts are a hostage to the fortunes of commodity markets. Chris Jeffery, Legal & General Investment Management
Chris Jeffery, head of inflation and rates at Legal & General Investment Management, says there is a yes and no case for stating that inflation is transitory. “Some of the biggest drivers of inflation are evidently transitory: the squeeze in the used car market and the spike in natural gas prices are the most obvious examples. But a series of cascading transitory shocks means that inflation has been high enough for long enough to impact wage-setting behaviour. “The problem with the ‘transitory’ versus ‘persistent’ debate is that, in this case, one leads to the other,” he adds. There are factors pointing to a transitory scenario, says Cathe- rine Doyle, investment strategist in the real return team at New- ton Investment Management. “Supply issues will undoubtedly continue to have some impact in 2022, albeit with pressures moderating. The steep rise in energy prices has also been a fea- ture in recent months. On this front there will likely be a mechanical improvement as the sharpest rises will drop out of the annual calculations in the second quarter of next year.” On this basis, Doyle notes there is a likelihood that inflation has peaked and will come down gradually. “Although, it is likely to settle at a higher level than in previous years. As the Covid recovery evolves, demand is likely to shift from goods to services, and in so doing, may drive more inflation on this side of the economy, which offsets some of the likely easing of pres- sure on the goods side,” she says.
This means the re-opening of the service side of the economy has implications for wage inflation, which has also picked up of late.
“While this will likely moderate in the medium-term, in the immediate future labour looks set to have a stronger bargain- ing position. “Furthermore, and especially in the US, rents, which form a not insignificant part of the inflation basket, are anticipated to see further upward momentum,” Doyle says.
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