Inflation is back in the mix that investors are having to build into their planning for the future. Markets in America were spooked by a growing belief that the CPI figures would be worse than expected and well ahead of the Federal Reserve Bank’s target of 2% - as indeed they turned out to be. A fall of a little over 1% in the S&P 500 Index as the week started was enough to send our own market sharply into reverse, with the Footsie initially dropping back below 7000.
A rise in the cost of living has been on the cards for a little while. The sheer size of the stimulation package introduced by President Biden made some sort of uptick inevitable and it does look as though the economy there has been kick started by these measures. The real question is whether the rise will be only temporary or if it has longer term implications. But strangely, despite worse than expected figures, markets calmed down once the news was confirmed.
Of course, inflation can have its benefits. Rising prices over a prolongued period devalues debt – and debt is a big issue right now. In the 1970s, very high inflation was a factor in bailing us out of an over-indebted position. It also helped significantly with wealth creation for the baby boomer generation, as house prices soared, while the value of mortgages declined in real terms. In the end inflation did moderate, but it is a genie that is difficult to rebottle once it escapes.
And one consequence of higher inflation that is not necessarily welcome in these constrained times is a likely rise in government bond yields. This has already started to take place and could have further to go. Aside from raising the cost of future borrowing for governments and corporates alike, such a development is likely to weigh on equity markets. The fact that any reaction so far has been limited suggests that expectations remain that any setback will be purely temporary. However, governments and central banks seem unlikely to take tough action to curb inflation with the global pandemic still in full swing.
We will soon see a further unwinding of lock down measures here, with the belief that our own economy will receive a boost as a result. As it happens, early signs are encouraging, with a useful bounce in our national output following a rather subdued start to the year. The first quarter results season has quietened down, but by and large businesses have exceeded expectations. This adds weight to the argument that we will soon regain the ground lost in the Covid caused recession. Let’s hope inflation doesn’t muddy the waters.
Brian Tora, Associate