Inflation – Cover story
expense of investments which are more leveraged to economic growth – like equities and real estate – but also provide a rea- sonable amount of protection against higher inflation,” an investment strategist told portfolio institutional.
Role of central banks
A big question in all this is how the Bank of England and other central banks have dealt with the situation adequately. “Record levels of peacetime debt and real interest rates of -5% don’t really reflect well on fiscal and monetary authorities,” Railpen’s Williams says. Central banks were arguably too generous in supplying liquid- ity, Dolyle says. “They had tolerance for inflation to overshoot on the upside since it had previously undershot on the down- side. They have now been compelled to act quickly to rein in liquidity which could represent a risk for markets leading to bouts of volatility,” she says. And Jeffery asks: “Are central banks willing and able to take the actions necessary to reduce price pressure by raising interest rates and ending asset purchases? “The answer to that is becoming ever clearer: yes. We have seen the first steps from the Bank of England, raising interest rates despite the economic threats of the Omicron variant,” he adds.
The next question is whether inflation is controllable without imposing more severe economic costs. “Here, we worry that investors – and central banks – have become too complacent that merely easing off the accelerator will be enough to bring inflation back down,” Jeffrey says. “In some parts of the world, notably in eastern Europe, central banks are clearly now apply-
ing the brakes. Our concern is that the Bank of England and the Fed may soon have to follow.”
An inflation trap
And some of the thinking underpinning inflationary analysis can be an issue that creates its own problems. A legacy of the Milton Friedman monetarist theory that inflation is always and everywhere a monetarist phenomenon is a problem for Trow. “I fear that we will again fall into the trap of believing that inflation is a problem that can be addressed by monetary policy alone,” he says. “Since the era of independent central banks, we’ve not really had a global example of stagflation, so rising prices and slowing growth is not something inflation targeting has been tested on.” Given the situation, do investors therefore have any easy tips in dealing with the inflationary outlook? “There are no good answers here,” Jeffrey says. “When inflation is a problem, pol- icy needs to constrain aggregate demand and expand aggregate supply. The first is economically and politically painful. “The second is incredibly difficult, as evidenced by the never- ending quest to improve the UK’s productivity growth. Focused measures to ease shortages in certain sectors can help in the short-run, but unless macroeconomic balance is restored this problem won’t disappear overnight,” he adds. Putting the whole picture into perspective by looking at things going forward over the next year, Williams says. “Inflation is topic du jour, but I suspect that something else will be the centre of attention in a year’s time – that tends to be the way in economics and markets,” he adds, ending with a caveat warning: “If inflation still is the main topic, then things could be very problematic.”
Flows by total AUM: Investor trends against the backdrop of rising inflation
2.000,0 4.000,0 6.000,0
-10.000,0 -8.000,0 -6.000,0 -4.000,0 -2.000,0 0,0
Q1 2015
Q2 2015
Q3 Q4 2015 2015
Q1 2016
Global Inflation Indexed Fixed Income Q2 Q3 2016 2016
Q4 2016
Q1 Q2 2017 2017
Q3 2017
Q4 Q1 2017 2018
Q2 2018
Q3 Q4 2018 2018
Q1 2019
Q2 Q3 2019 2019
Q4 2019
Europe Fixed Income - Inflation Indexed UK Inflation Indexed Fixed Income Q1 Q2 2020 2020
Q3 2020
Q4 Q1 2020 2021
Q2 2021
Q3 2021 Source: eVestment Issue 110 | February 2022 | portfolio institutional | 23
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