Inflationary Fears
January 25th, 2011
Inflation has become a predictable worry of investors in 2011. Last year many tried to ignore the gathering price problems in India and China. Some still agonised over whether we could enter a new deflationary phase. Price rises seemed under good control in the USA and the EU, whilst wages were far from lively even in more inflation prone UK.
Despite this, last year the UK government removed inflation linked Savings Certificates from sale, whilst index linked gilts offered little positive yield. Some concerned investors put index linked bonds or gold or equity based investments into their portfolios as possible hedges against inflation. This January in the UK many are worried by the pace of price rises. Food and clothing, fuel and fares are all on the rise. Commodity prices worldwide have risen considerably, whilst at home VAT and other taxes have added to public sector fees and charges to provide a further twist to the inflationary spiral. The full effects of past devaluation are being felt, as we import so much of what we buy.
Few think inflation will get out of control in the way it did in the 1970s. There are no signs of people being able to gain substantial wage increases to offset the full higher costs from price rises. The pound is a bit more stable, so the rapid rises from devaluation will gradually abate. VAT has gone up two years running in January, but should not go up again in 2012. The Bank of England keeps telling us it is all a blip, yet it is proving quite a big and persistent blip. However, you can make a case that by this time next year there should be better news on the inflation front in the UK.
What does all this do for investors? It seems a bit late to rush for inflation hedges if you do not already own them, as many of them reflect in their prices what we are now living through. It does mean that worldwide we should expect further rises in interest rates, as India and China seek to catch up with their rapid inflation, and as the west starts to normalise rates after a long period of very low inflation.
It is an added complexity for Central Banks. In the aftermath of the Credit Crunch they got used to being free to ignore the inflationary dragon. They could encourage new credit, print extra money, depress interest rates as low as possible, and assume inflation would take care of itself. Now the countries trying to dig themselves out of too much public and private sector debt have also to worry about the inflationary impact of any excess credit or very low rates. They share a world with large and fast growing emerging market economies, putting considerable demand pressure on prices of basic materials and commodities.
It just means there is a bit more risk around. Markets are no longer such simple one way bets as they were in 2009-10 coming out of the Crunch, driven by easy money in many parts of the world. Investors need to be more selective, and aware that getting out of debt can bring all sorts of pressures. Heavily indebted countries may like a bit of inflation, and devaluation, to whittle away the real value of what they owe. If they let that happen too much the lenders will demand much higher interest rates for any new borrowings. That is why we are now seeing more of a tussle in the bond markets, with many thinking now that government bonds in particular have offered too little for too long.
As published in Investment Week
