• CPI inflation has risen to 0.7%, according to the latest data from the ONS
• Motor fuels and clothing have pushed the rate up
• Is inflation or deflation in charge?
• The ramifications of inflation for markets
• Investors should be on high alert
Laith Khalaf, financial analyst at AJ Bell, comments:
“The spike in inflation is nothing to worry about - yet. We always knew inflation was going to rise once we started lapping the beginning of the pandemic, in particular the steep falls in energy prices witnessed in the spring of last year. Petrol prices were 4.3p higher in March than a year ago, when they stood at 119.4p. In May 2020, they dropped to 106.2p, so this upward pressure on inflation will continue to grow in the coming months, even if fuel prices are relatively stable now.
“But CPI is still way below target, and this isn’t the kind of embedded, long term inflation that will cause sleepless nights for anyone at the Bank of England. The Bank has looked through much higher inflation before, so interest rate rises remain very much in the long grass. The big question is whether the economic recovery, combined with fiscal and monetary stimulus, will start to foster a more sustained, inflationary trend that has the potential to get out of hand. This risk isn’t likely to come home to roost anytime soon, with unemployment expected to rise later this year, thereby acting as a drag on rising wages. But beyond that, the worry is that the powder keg of cheap money could ignite an inflationary spiral.
“However, any surge in prices will have to overcome deflationary forces and risks at play in the UK too. While the vaccine rollout has been hugely successful to date, it remains to be seen whether it ultimately prevents further lockdowns. We also don’t know if a significant chunk of consumers are going to remain guarded in their social interactions, even once vaccinated. The pound has also been on the rise, reducing the price of imported goods on the shelves. Meanwhile the longer term trends of technology and ageing demographics in developed economies continue to exert downward pressure on consumer prices. And though the Chancellor is currently in spend and splurge mode, he’ll be using fiscal drag to increase the tax take from April 2022, transferring wealth from consumers’ pockets into the big black hole in government finances.
“For the moment, inflation looks well contained, but if there is a shift in inflationary expectations, this would have big ramifications for investors and markets. Bonds in particular could suffer a hefty sell-off, as their fixed income streams are particularly vulnerable to inflationary erosion. Indeed, these safe haven assets have already seen significant price falls this year, as vaccine optimism has taken hold. The shares of companies reliant on distant cash flows could also find themselves under pressure, as the discount rate used to value those earnings rises. So while consumer price rises look subdued for now, investors should be on high alert for any signs of change. Inflation is a potential problem for 2022 rather than 2021, but if markets get a whiff of it coming down the road, prices could adjust rapidly.”
