Inflation: Where Are We Headed?

While daily Covid-19 figures continue to dominate headlines, another statistic is causing a stir around the globe; the topic of inflation and when will we see significant inflation coming through.

While some economists are warning that the currently rising inflation rate could be dangerous for the economy, on balance, the consensus seems to be that the increases will not last.

What is causing the rise?

Alex Funk, Chief Investment Officer of investment partner Schroder Investment Solutions (SIS), suggests inflation is higher in the near term because of the rise in commodity prices and the impact of the re-opening of the service sector. The markets are for now taking the view that the inflationary spike is a transitory effect of the economic recovery. The Bank of England has forecast 2.5% inflation in the final quarter of 2021 but, looking further out, inflation is expected to keep on building as the output gap closes and capacity tightens at the beginning of 2022.

A May inflation rise was widely discounted, but the magnitude of the increase was greater than expected.

Source: ONS

What next?

Alex and his team feel that the recent increase in inflation is largely a consequence of the rise in commodity prices and the rapid pace of recovery which has created bottlenecks in some sectors of the world economy. Growth in 2021 will be the fastest in the 21st century (source: Schroders) and, while there is significant spare capacity, it cannot be put in place rapidly enough to prevent shortages of materials, parts and labour emerging in the short term.

The recovery in growth is being driven by a re-opening of the service sector and so favours the advanced economies over the emerging markets. Consequently, the upgrade is led by the US and Europe with only a minor increase in the emerging market forecast. The differential is reinforced by the greater availability of vaccines and fiscal support in the developed economies. Such an outcome is a contrast with the recovery from the last recession when massive stimulus in China led the emerging markets out of the global financial crisis (GFC). While it is thought that the current inflation spike will prove to be temporary, experts do see inflation picking up next year and the need for a tighter monetary policy from the US Federal Reserve (Fed).

As with any long-term investment strategy, the key is not to panic, a sentiment supported by the Bank of England governor who has warned against an over-reaction to rising inflation (source: BBC).

How can you hedge inflation?

While Alex will incorporate ‘best ideas’ into our SIS portfolios we thought a look back on those asset classes that have historically provided the best hedge against short term inflation would be interesting.

Source: Visual Capitalist

Part of our role at Finura is to ensure Clients select an investment appropriate for their risk profile and objectives and, along the journey, help them to tell the difference between temporary volatility and permanent loss. This will include factoring the impact of inflation on portfolios. However, if you are holding a significant amount of cash or low yield investments, we would encourage you to have a conversation with your financial planner, who you can contact here.

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Sources:
https://www.bbc.co.uk/news/business-57679371
https://advisor.visualcapitalist.com/which-asset-classes-hedge-against-inflation/
https://www.schroders.com/en/uk/private-investor/insights/economics/could-global-growth-this-year-be-the-fastest-this-century/