Post lockdown booms and higher prices have elevated inflation around the world as supply bottlenecks, shipping distribution and recovering demand have been driving up prices.
Higher commodity prices and cost of energy have also been lifting headline inflation. Currently these higher prices have forced some Emerging Market (EM) central banks to already act. Brazil, Mexico, Russia, South Korea, and parts of central and eastern Europe have already started increasing their interest rates, while others are willing to wait.
However, investors should not be too worried about the upward move in inflation across much of the EM’s. It should be viewed as an expected part of the economic normalisation of the post Covid-19 crisis.
Outside EM’s, central banks have so far taken the view that these pressures are transitory and will sort themselves out, but it is not that simple. It is worth thinking about the changing forces behind inflation as they arguably point to longer higher prices.
The UK annual inflation rose to 3.2%, a jump of 1.2% since July. Rising prices for food, hotels, and transport were behind this increase in the consumer price index (CPI). The Office of National Statistics (ONS) has stated this cost-of-living raise is likely to be temporary due to last August’s food prices being artificially lower during the ‘Eat Out To Help Out’ scheme, time will tell.
On 17th October the Governor of the Bank of England (Andrew Bailey) spoke at a virtual meeting of the G30 group of current and former central bankers. Bailey affirmed his view that recent spikes in inflation will be temporary. He also warned that price increases could last until next year, specifically citing the energy sector. This comment comes ahead of the latest UK CPI numbers when inflation for September is expected to remain unchanged at 3.2%, according to consensus. The Bank of England’s inflation target remains at 2%.
Unless wages keep pace with rising costs, inflation is generally negative for consumers, but what does that mean for investors? Inflation is perhaps the biggest topic for global investors, following Covid, the logical question is what action central banks plan to take to tackle it and when.
Leading investment banks are reporting that rotation is happening everywhere, from growth shares and risk assets such as Emerging Markets into classic value sectors such as energy, cyclicals, and financials.
Investor unease is the highest it has been for some time as rising inflation tends to be seen as bad news for markets. For equities, it can make it harder for some companies to increase their earnings growth if they do not have any pricing power and operate in very competitive industries. With bonds, having a fixed return, inflation eats away at those returns. However for other sectors such as, energy shares, real estate investment trusts and consumer staples business inflation can lead to higher profits.
Whatever the conditions choosing the right investments, is what we endeavour to do.
Stephen Lovelock