Inflation is back on everyone’s minds. Central banks are pointedly ignoring it, fund groups are writing more about it, and investors are starting to fret about it, but whatever your take, it’s top of the agenda as we emerge from the pandemic.
This week’s reading (19 May release date) in the UK is understandably being closely followed, with expectations that we could see the official figure jump above 1% for the first time since July 2020. It could close in on pre-pandemic rates of 1.5% and above, over the next few months.
The near-term path looks quite clear; central banks have said they expect it to be transitory, and they are claiming to look through it, rather than react and try to quash it.
However, a growing number of investors and experts are expressing doubts about letting the inflation genie out of the bottle. And markets are reacting as a result.
Rampant inflation history
The last time inflation exploded out of control in high-income countries was the 1970s, and the UK was at the heart of it.
In August 1975, year-on-year retail price inflation in the UK (then the relevant reading) hit 27%, and this wasn’t a one-off, with similar moves in subsequent years. Other countries experienced similar spikes, leading to interest rates in the double-digits.
Fast forward to now and we are clearly in a very different world, but there are signs of concern. Last week the US, which is recovering quickest from the pandemic according to most economic readings, recorded a much higher than expected reading of 4.2% for inflation in April, smashing forecasts.
The policies fuelling this are well known, with QE and ‘helicopter money’ – the process of handing money directly to citizens so they can spend it to restart the economy – having some clear side-effects.
Former US treasury secretary, Lawrence Summers has warned against it, telling Bloomberg: “These are the least responsible fiscal macroeconomic policies we’ve had for the last 40 years.”
The UK is following the same path, and while it is taking our economy longer to rebound, with much of the uncertainty around Brexit now fading, the expectation is for a similar bounce back over here.
All of this spending – and crucially without much by way of taxation to counter it – means many believe the chances of an inflationary overshoot have substantially increased.
What can advisers do about it for clients?
The good news for advisers is that there are a number of well-known hedges to protect investors’ purchasing power over the long run (as well as some clear areas to avoid).
Firstly, cash looks challenged as a store of value. With average inflation of just 1% over 10 years, the value of £10,000 in cash savings would be eroded to just £9,052, according to one inflation calculator.
On the plus side, both shares and commodities present opportunities. Over the long-run, equities in particular have delivered inflation-beating returns, and they present the clearest option to hedge portfolios.
Gold and other commodities also present a chance to protect portfolios, with the precious metal renowned as a classic counter to inflation thanks to its role as a store of value globally.
Perhaps the biggest challenge is for income-seekers using fixed income assets. With average yields near record lows at present, there is a real risk of capital losses as bond yields adjust (and bonds sell-off) to account for any future upticks in inflation.
Only higher-yielding bonds – which are inherently riskier – would be able to withstand higher inflation, but the days of buying government-bonds to get a decent income are long gone.