That UK consumer price inflation increased again in May, to 2.9%, will not have surprised many British grocery shoppers (1). Already at or above the level the Bank of England predicted last month for the final quarter of this year, inflation has shown it has the ability to surprise to the upside (2).
This inflation, though still muted compared with history, is arguably of the wrong kind. The right kind, if there is such a thing, would come as a result of a booming economy where demand is outstripping supply.
However, some of the vital ingredients for a boom are missing. True, the UK’s unemployment rate is as low as it’s been this cycle – 4.6% currently – but wages (up at a 2.1% annual rate in the three months to April) are now rising more slowly than inflation (3).
In the US, a boom might seem more likely. The US hasn’t experienced currency depreciation like the UK, unemployment – at 4.3% – is even lower than Britain’s, and America doesn’t have the uncertainties of Brexit hanging over it (4).
Despite this, US economic growth slowed in the first quarter of the year, to a pedestrian 1.2%5. Consumer price inflation was just 1.9% last month too, and below the Federal Reserve Bank’s 2.0% target (6).
In Japan, achieving higher inflation remains a key objective. Last September, Japan’s central bank radically amended its policy, pledging to continue printing money until inflation exceeds its 2% target and stays there (7).
Nine years after the onset of the global financial crisis, the old rules about how economies are supposed to respond to exceptionally low interest rates appear to have been broken or, at least, temporarily suspended.
Theoretically, low unemployment in the US ought now to be driving competition between businesses for workers. In turn, that ought to be pushing up wages, the buying power of consumers and inflation.
However, there is little sign of that happening and it could be because of an unsubtle shift in worker attitudes.
The global financial crisis was like the tide going out. It revealed changing pressures across society and heightened worker insecurity. The impetus to accept part-time or low-paid work increases in this environment. So it could be that today’s workforce, in the US and elsewhere too, is helping to keep unemployment and wages down at the same time.
A report on low pay by the Resolution Foundation published last October found that the post-crisis downturn in pay in the UK had left a persistent scar on average earnings (8).
This possibility is, understandably, creating a dilemma for America’s central bank. The traditional thinking – which seems to be at the central bank’s core – has it that very low unemployment equates to higher inflation in the pipeline. Pre-emptive rises in interest rates are therefore required.
However others beyond the Fed will have been unnerved by the real-world evidence pointing to a lack of impetus in today’s inflation numbers.
It’s not that central banks haven’t been thinking about why growth hasn’t been stronger. Fed Chair Janet Yellen suggested, in response to a question at the press conference held after last week’s policy setting meeting, that the idea of central banks adopting higher inflation targets warranted further research (9).
The main incentives to have a higher inflation target are twofold. First, it would allow inflation to run higher before interest rate rises were needed. In effect, it would give an economy a head start in a recovery.
It could cause consumers to spend more today in expectation that prices would rise significantly in future. Businesses too might be propelled to invest more heavily in the knowledge that central banks would be slower to curb growth.
Second, it would most probably result in the eventual implementation of higher interest rates. That would give central banks more scope to cut rates when economic conditions turned bad.
No major central bank has turned to such measures yet, and no such move is signalled in the near term. However, clearly there is a potential to do so.
So what can investors do to shield themselves against the effects of inflation? One way is to commit a proportion of their investment portfolios to real assets. These could be assets like property or infrastructure, which have the potential to keep pace with inflation; or even the likely sources of inflation themselves – commodities such as oil or industrial metals. Another way is to emphasise growth companies, with the pricing power necessary to maintain a competitive edge.
Fidelity’s Select 50 list contains several funds in both categories. They include the BlackRock Global Property Securities Equity Tracker Fund, which invests in a diverse range of commercial properties worldwide, and the CF Lindsell Train UK Equity Fund, with its high conviction holdings in UK companies with strong brands and leading market positions. The Rathbone Global Opportunities Fund is a highly selective and relatively concentrated fund focused on companies offering sustainable growth.
Graham Smith, Market Commentator
Graham has worked for some of the biggest names in the City, including Schroders, Invesco Perpetual and Gartmore, as well as the World Economic Forum in Davos. Today he writes independently on a range of market and investment issues.
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1 ONS, 13.06.17
2 Bank of England, 11.05.17
3 ONS, 14.06.17
4 Bureau of Labor Statistics, 02.06.17
5 Bureau of Labor Statistics, 14.06.17
6 Bureau of Economic Analysis, 26.05.17
7 Bank of Japan, 21.09.16
8 Resolution Foundation, October 2016
9 Federal Reserve Bank, 14.06.17
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