David Jane
Premier Miton Macro Thematic Multi Asset Team
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Inflation acceleration
Inflation worldwide has accelerated over the last few years and commentators have positioned a range of reasons for its re-emergence. What certainly is the case is that lockdown era policies were the spark that set it off.
UK public debt, consumer price inflation and Bank of England base rates
Source: Bloomberg data from 23.06.2014 to 21.06.2023
Once more unto the breach
Public debt has grown very rapidly in recent years and now has breached the key level of 100% of GDP. This reflects some of the most generous payments during the lockdowns and the inexorable growth in public expenditures subsequently. Naturally, growth of government consumption, either directly or via transfer payments, without a simultaneous growth of private sector production, is inflationary when financed by borrowing
On the monetary side, the UK has been aggressively raising interest rates, but policy arguably remains loose. The problem being the consumer sector in the UK is one of the most rate sensitive among major economies. With several of the recent stimulus measures having been targeted at homebuying, there is a large cohort of recent homebuyers that have been encouraged to take on mortgages. These may suffer greatly as higher rates feed through. This, no doubt, is leading the central bank to be less aggressive than perhaps it should be.
No longer feeling the force
In the long term the UK’s inflation problem is part of a wider worldwide issue. The disinflationary forces of the past few decades have arguably reversed. Globalisation is a spent force. Cheap energy, from fracked oil and nuclear is being replaced by more expensive solar and wind. A long-term underinvestment in other extractive industries means that many minerals are set to be in short supply, despite increasing demand.
Finally, government efforts to control inflation thus far involve more unproductive subsidies and these expenditures may lead to more inflation.
If economies slow, and especially if there is a recession, it is reasonable to expect inflation to continue to fall in the near term. Thus far, the rate hikes appear to have had little, if any, effect on the US and UK economies, despite a lot of talk of a squeeze on homebuyers. Rates are known to operate with a lagged effect and therefore, we may see an economic contraction later this year, or early next.
We think the end of the era of near zero interest rates and the re-emergence of inflation at a higher level is not necessarily a bad thing. Ultra-low rates can encourage poor investments while moderate inflation acts as a lubricant of a growing economy. Additionally, the real value of public debt could be quickly inflated away.
Proper preparation
If we are right, and higher inflation remains a feature of the economy for the longer term, then a lot of recent approaches to portfolio construction and stock and sector allocation may need to change. Very different companies may do well in the higher inflation economy. Bond yields may remain high and rising for an extended period, meaning bond investment may be less of the easy ride that it has been in recent decades.
We are fully prepared for this ongoing environment although we remain conscious that it will not be a straight line upwards and, indeed, inflationary environments are typically more volatile than the recent lower for longer has been.
