Inflation: up, up and away?
Inflation expectations are rising with encouraging signs of a relatively swift vaccine-fueled recovery in some of the largest economies. We look at inflation prospects and what these might mean for policymakers and investors.
- Relatively swift economic recovery looks likely
- Pent-up demand and fiscal programmes fuelling higher inflation forecasts
- Projected UK, Europe and US headline inflation may be one percentage point higher this year than last
- US, eurozone and UK central banks set to keep rates on hold this year and next
- Portfolio diversification is key to weathering inflation while protecting wealth.
A shockwave has reverberated through financial markets since February as the unleashing of pent-up demand, overwhelming fiscal support and surging commodity prices prompted economists to hike inflation forecasts. Similarly, government bond yields have climbed as investors revaluated central banks’ commitment to maintaining interest rates at historically low levels for a prolonged period.
It may be time for investors to gauge if persistently rising prices might force rate hikes and consider the need to adjust portfolios to mitigate the risk.
Stronger recovery hopes
The administering of vaccines around much of the world has accelerated the timeframe for the normalisation of activity. The vaccine rollout promises fewer new infections and lifts chances of a revival in service industries and eventually employment prospects.
We now project that the global economy will grow at 6.4% this year, up from a 5.6% forecast in January.
Building inflationary pressures
Governments are turning on the spending taps in response to the pandemic, fuelling inflationary pressures. The International Monetary Fund estimated in January that governments have committed $14tn to saving lives and livelihoods.
President Biden’s $1.9tn relief bill, passed in March and the second largest US stimulus package, includes direct cheques to consumers, extension of unemployment benefits and funds for vaccination distribution programmes. The aid should temporarily supplement income and government spending while the economy is weighed down by the pandemic.
Focus on commodities
Commodity prices form a high weighting in consumer price indexes and can quickly influence inflation forecasts. The anticipated recovery, infrastructure investment and climate change initiatives are pushing energy, metal and agricultural prices higher.
The total return on the Bloomberg Commodity Index is 34% over the past year. Investment houses increasingly predict a commodities supercycle is on the way. If commodity prices maintain their upward trajectory they would push prices higher, particularly in countries that have to import vast amounts of raw materials.
Are pricing pressures temporary or sustainable?
Given the broad range of inflationary pressures, it’s perhaps no surprise that year-on-year inflation may significantly rise this year in the UK, Europe and US.
That said, some factors suggest that the inflationary pressure being seen is transitory. Unemployment rates are elevated, compared to pre-pandemic levels, yet the wage growth often associated with core inflationary pressures has not being seen. The rapid digitisation and investment in technology may keep wage growth muted, even when labour markets recover.
The arresting of the coronavirus outbreak is far from assured. Unknown vaccine efficacy levels against future variants could also affect the recovery and, in turn, price pressures.
Short-term inflation forecasts
Barclays forecasts that the US Federal Reserve’s (Fed) preferred domestic inflation level, the core personal consumption expenditures (PCE) index, will hit 2.2% in the second quarter, easing to 1.8% in the third quarter and 1.9% in the fourth, then averaging 1.8% next year.
European inflation forecasts have risen, but weak underlying consumer prices pressure is expected to keep inflation subdued in the medium term. The euro area CPI will likely average 1.5% this year and drop to 1.1% in 2022. Meanwhile, our projections are for UK CPI to average 1.9% this year and 1.8% next.
Are rate hikes on the way?
The impact of stronger inflationary pressures on monetary policy is likely to be more muted than this year’s increase in bond yields suggest. This is due to inflation forecasts remaining below central banks’ mandated levels. We expect that the Fed, European Central Bank and Bank of England will keep rates on hold this year and next.
Wealth preservation and inflation
In order to preserve the long-term purchasing power of their wealth, investors need to generate a return that is equal to or preferably higher than inflation. However, even moderate price rises can start to cause meaningful damage to wealth preservation assumptions. For those seeking protection, there are a wide range of options available to mitigate inflation risk by using equities, fixed income and precious metals.
Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.
- Has been prepared by Barclays Private Bank and is provided for information purposes only
- Is not research nor a product of the Barclays Research department. Any views expressed in this communication may differ from those of the Barclays Research department
- All opinions and estimates are given as of the date of this communication and are subject to change. Barclays Private Bank is not obliged to inform recipients of this communication of any change to such opinions or estimates
- Is general in nature and does not take into account any specific investment objectives, financial situation or particular needs of any particular person
- Does not constitute an offer, an invitation or a recommendation to enter into any product or service and does not constitute investment advice, solicitation to buy or sell securities and/or a personal recommendation. Any entry into any product or service requires Barclays’ subsequent formal agreement which will be subject to internal approvals and execution of binding documents
- Is confidential and is for the benefit of the recipient. No part of it may be reproduced, distributed or transmitted without the prior written permission of Barclays Private Bank
- Has not been reviewed or approved by any regulatory authority.
Any past or simulated past performance including back-testing, modelling or scenario analysis, or future projections contained in this communication is no indication as to future performance. No representation is made as to the accuracy of the assumptions made in this communication, or completeness of, any modelling, scenario analysis or back-testing. The value of any investment may also fluctuate as a result of market changes.
Barclays is a full service bank. In the normal course of offering products and services, Barclays may act in several capacities and simultaneously, giving rise to potential conflicts of interest which may impact the performance of the products.
Where information in this communication has been obtained from third party sources, we believe those sources to be reliable but we do not guarantee the information’s accuracy and you should note that it may be incomplete or condensed.
Neither Barclays nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation. Law or regulation in certain countries may restrict the manner of distribution of this communication and the availability of the products and services, and persons who come into possession of this publication are required to inform themselves of and observe such restrictions.
You have sole responsibility for the management of your tax and legal affairs including making any applicable filings and payments and complying with any applicable laws and regulations. We have not and will not provide you with tax or legal advice and recommend that you obtain independent tax and legal advice tailored to your individual circumstances.
THIS COMMUNICATION IS PROVIDED FOR INFORMATION PURPOSES ONLY AND IS SUBJECT TO CHANGE. IT IS INDICATIVE ONLY AND IS NOT BINDING.