Feature – Inflation
International Finance, stresses that investors should be careful not to conflate the monetary base with money in circulation. “This is similar to what we saw post the global financial crisis,” she says. “The money multiplier changes and the financial sys- tem is more complex than just central banks printing money, banks transmitting it to corporates and individuals and those spending more.
“On the one hand everyone is more cautious during any shock, more money is saved rather than spent,” she adds. “In, addi- tion, it is not only banks that intermediate interest rate changes/or base money supply changes by central bank.” Stuart Trow, credit strategist at the European Bank for Recon- struction and Development and trustee of the bank’s pension scheme, adds that broader structural trends have dampened price levels.
“Inflation is supposed to be the indicator that the economy is getting out of whack, but, for whatever reason, I happen to believe it’s globalisation and technological advances, we have actually had quite a lot of supply side dampening on inflation since the mid-80s and that’s why it has been so difficult for central banks to get price levels up again,” he says.
Could the tide be turning? Nevertheless, there is now a growing concern that a new trend could be emerging. While it is unclear whether the growth in money supply could feed through to higher inflation, the slow- down in global trade as a combination of Sino-US trade wars and the effects of the Covid lockdown could also push up price levels. Trow argues that while it is hard to deduct longer-term trends from a one-off figure, the July inflation data could be a sign that the tide is turning. “It does show that there are pressures feed- ing through, particularly for the services sector where there isn’t any international competition. They might have no choice but to feed through rising costs because otherwise they’re gonna go out of business,” he warns.
Ribakova adds that a pick-up in commodity prices, those for oil in particular, could also affect headline inflation in the medium term, particularly given the extremely low oil price at the begin- ning of the year. However, she believes that this effect would only be temporary. “Central banks are likely to look through the first round effects of commodity prices as long as they don’t spill over into other sectors and affect core inflation.” Ribakova is also sceptical that a surge in demand due to faster than anticipated economic recovery could lead to a rise in price levels. “We see a surge in demand as an unlikely scenario as we are still seeing second waves of infections in many countries and no vaccine yet,” she says. Trow is more wary about a long-term shift and argues that we may have reached peak globalisation. “The effects of interna-
30 | portfolio institutional September 2020 | issue 96
The inflation outlook for the next 12 to 18 months is probably the most uncertain it’s been in my 15-year career of trading inflation-linked products. Evan Guppy, Pension Protection Fund
tional trade are not as readily available now and added to which we have a huge amount more cost in the system as well. I’m not expecting inflation to jump up straight away but the predis- position for prices to rise when growth resumes will be greater now than it has ever been up until Trump came in and started slowing down global trade.”
Another reason why many investors have started fearing infla- tion is that a rise in price levels could be seen as politically desirable for central bankers, as states are having to tackle growing debt levels. While central bankers are yet to admit that the 2% inflation target pursued in the US, UK, Europe and Japan has become increasingly redundant, a rise in price levels would help states tackle their growing debt level as a result of the Covid crisis. Indeed, Fed chairman Jay Powell acknowl- edged in his latest Jackson Hole speech that inflation moder- ately exceeding the 2% threshold would be seen as a desirable trend.
RPI reform But securing a portfolio against inflation risks is far from straight-forward. While the price of traditional inflation hedges such as gold has surged globally, for the UK in particular, index-linked gilts have traditionally been a weapon of choice
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