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Inflation – should we worry?…

Inflation is a bit like that intense and slightly eccentric friend. Sometimes overbearing, though a little exposure now and then is not only tolerable but can also prove energising and invigorating.

At the start of every year economists across the globe come out with their forward forecasts for inflation. Almost always expectations are for prices to increase quicker than we expect. Just like the odd catch up with Sam (my eccentric friend), some inflation can be good after all, if driven by strong economies which lead to wage increases and subsequently more spending. As more money chases the same number of goods and services, prices increase.

Inflation has remained stubbornly low since the global financial crisis in 2008. Partly that’s a reflection of economies being slow to recover, as average salaries have stagnated not grown. There are also other factors at play though, which are worth mentioning as we try to forecast where inflation could go from here.

Let us start with the ‘Amazon effect’, a new term that refers to technology causing downward pressure on prices by vastly increasing competition to the high street, exploiting the speed and convenience at which we can shop online. Then we have demographic trends – we are getting older as a collective, which means the ratio of people working and producing for each person who simply ‘consumes’, is falling.

Finally, we have debt. With interest rates very low, it is easier to convince people to buy now and spread the cost forward, rather than save up over 3 years and buy it then. The point about buying now is that it reduces the amount available to ‘consume’ in the future, so the more debt we have, the less capacity for spending in other areas, keeping prices lower.

So a combination of those long term trends, and a generally slow decade for the economy has kept price rises low. As we emerge from Covid, we are keen to watch the behaviour of our old friend Sam. Will he be out and about spending lots of money he has saved up over the last 12 months? Or will it have changed his spending habits completely? In addition, given that policymakers have provided more support than we’ve ever seen before on a global basis to help economies get through this period, have we now entered a completely new economic cycle.

The short answer is we do not know. We have never been in this position after a recession before. Usually, unemployment is in the double digits and most people are much worse off. This time, whilst more job losses are likely, unemployment is currently still only 5% in the UK, the same level as in 2016, and as mentioned, savings are high, and when its safe, many people will be raring to get back to ‘normal’.

Now our job isn’t about forecasting inflation. Its understanding that inflation is one of the possible outcomes, along with several others, and mapping forward the implications of these ‘scenarios’ on our portfolios and the assets within them. One major consideration is that if we do have a post-lockdown boom, after years of extremely accommodative interest rates, Central Banks may start to alter their course. This would likely happen slowly, but the negative knock-on effects for certain assets, namely cash and fixed income would be significant. Areas of the economy which have felt the riskiest, such as travel, leisure and consumer spending sectors (those who manage to emerge from Covid), may be primed for material recoveries, likely driving their share prices as well. So whilst there are potential short term wins here, timing is tough and certainty is in low supply.

Thankfully, whilst it will be great to have Sam around a bit more in the future, he’s likely to get bored and move on at some point. Those factors of debt, demographics and technology will continue to be long term drivers of lower prices, so like any boom it will probably lose its fizz before long. You can have too much of a good thing! Meanwhile other opportunities will emerge elsewhere, as one door closes, another opens. Its our job to check that if Sam turns up, we are ready for him.