Ben Brettell, Senior Economist, Hargreaves Lansdown: “Inflation ticked up again in August, with increased petrol and diesel prices contributing to a year-on-year figure of 2.9%, up from 2.6% in July and matching May’s four-year high.
“This will inevitably raise questions about the UK’s ongoing cost of living squeeze. Data released tomorrow is expected to show pay increasing at 2.2% in the three months to July, meaning wages are still shrinking in real terms.
“Yet it looks likely that inflation will fall back in the coming months, as the effect of Brexit-induced sterling weakness falls out of the year-on-year calculation. Indeed it’s possible that 2.9% will be the highest we see in the current cycle. Mark Carney will certainly be hoping so, as it will save him the trouble of writing to the chancellor to explain himself.
“Beyond the currency effect there appear to be few underlying inflationary pressures. Labour costs are the main factor in domestic inflation, and growth here remains below long-term averages. Productivity growth is sluggish, and technological changes look to be suppressing wages, with the likes of Uber, Amazon and Netflix disrupting traditional industries.
“Furthermore we need to consider demographics. The baby boomers are retiring in their droves. They have already gone through their consumption phase – they have bought their houses, cars and consumer goods. The generation behind them is saddled with debt and struggling to get on the housing ladder.
“All in all I see more deflationary forces than inflationary in the world economy at present.
“All this means less pressure on the Bank of England to consider raising interest rates, and will allow the MPC to remove the sticking plaster of ultra-low interest rates as slowly as they like. Rates are a racing certainty to be left on hold at this week’s meeting, but as ever the minutes will be closely scrutinised for clues as to committee members’ latest thoughts.
Alex Brandreth, Deputy Chief Investment Officer and Senior Fund Manager at Brown Shipley, said: “Inflation is expected to continue to increase, at least for one more month, with the Bank of England recently stating that they believe inflation will peak at 3%.
“Inflation has been increasing because of the fall in sterling and importing more expensive goods, with the pound weak against major currencies because of the Brexit vote. However, as the vote and subsequent slide in sterling was now over a year ago, the effects should be starting to work through the annual inflation calculation as we move towards the year end.
“Over the long term, inflation is rarely a country-specific phenomenon, especially for developed, open, market economies. Global inflation is running below expectations and there is a low inflation phenomenon that has immersed the global economy.
“The combination of this along with high levels of debt, creates the threat of deflation – the stuff of nightmares for central bankers – and explains why they remain so cautious to ‘normalise’ monetary policy at present.”
Vince Smith-Hughes, retirement expert at Prudential, said: “Relatively high inflation figures give financial advisers an opportunity to help their clients understand how much income they can withdraw without running out of money. Advisers tell us that many savers are unrealistic about how much money they need in retirement and two-thirds say running out of money is the biggest risk facing their clients. A comprehensive drawdown review using cashflow modellers will help clients understand how much they can drawdown without exhausting their funds. Using a modeller which also shows average longevity can really help to bring this to life.”
Kate Smith, Head of Pensions at Aegon commented: “Increases in the cost of living are continuing to strain UK household budgets, as inflation has breached the Government’s 2% target for the seventh month in a row, with people on fixed incomes, such as pensioners the hardest hit. In the past, the Bank of England would increase interest rates as a tactic to reign in people’s spending to keep inflation in check. However, the last increase in the base rate was over ten years ago and the last movement in rates was a downward one, last August, which has only added to pensioners’ woes. Many retirees are faced with a double whammy, not only being locked into a fixed income, but also unable to rely on their cash savings to protect them from inflation with near zero interest rates.
“Two thirds of people have taken no steps whatsoever to protect their savings and investments against the erosive effects of rising inflation which can have a devastating impact on people’s standard of living. In 14 years’ time when Prince George is contemplating his first day at university, if the cost of living continues to increase at the current 2.9% a year, £100 in today’s money will be worth only £67. If this continues, in less than 25 years, people’s purchasing power will be cut in half. As people are living 20 or more years in retirement they need to think seriously about how they can protect their standard of living and avoid being forced into cutting their spending to the bone. Planning ahead and investing to outstrip the destructive effects of inflation could help maintain purchasing power. Getting professional advice could make all the difference.”
Shilen Shah, Bond Strategist at Investec Wealth & Investment, said: “The CPI print for August surprised on the upside with YoY figure coming in at 2.9%, against the consensus forecast of 2.8%. Interestingly, the core CPI figure was also higher than expected at 2.7%, suggestion some of the pass-through effects of the fall in the currency impacting non-core goods and services. Post release of the inflation data, Sterling has rallied strongly against both the Euro and US Dollar, suggesting that the market is looking for a reaction from Thursday’s MPC meeting. The BoE has shown patience with above target CPI prints, however some reduction in the dovish bias and a move towards a more neutral or even a few hawkish comments is currently expected by the market.”
Cynthia Bowring, Portfolio Manager at Sanlam UK: “The UK’s consumer price index (CPI) came in at 2.9% in August – 0.9% above the Bank of England’s target of 2%, and well above the 0% figure of two years ago. Although we don’t think there is much reason to believe this trend will continue (if anything, it should fall back towards the government’s target of 2%), we thought we would look at the impact of rising inflation on investors, and how we manage portfolios to mitigate the risk it imposes.
The impact of low interest rates, and low inflation
“Since March 2009, consumers and businesses have enjoyed the bank base interest rate of 0.5% or less, enabling small businesses to flourish due to the availability of cheap credit, and making homeowners feel better off due to the fall in repayments on their mortgages.
“But for savers and investors, this low interest rate environment has not been so accommodating, and this has become more pronounced as inflation has increased. For those wishing to make decent returns on their savings, they have been forced to look beyond high street accounts – perhaps to government and high quality corporate bonds, or equities for those with a higher risk appetite.
“This ‘hunt for yield’ has been well publicised and, as portfolio managers, it’s our job to protect our clients’ wealth from rising inflation at a time when interest rates, and therefore bank account rates, are unlikely to rise dramatically in the near term. So how do we go about it?
The role of bonds
“As any textbook will tell you, higher inflation causes bond prices to fall, as investors worry that bond yields will not keep pace with the higher interest rates required to tackle rising inflation. Despite this, government and corporate bonds play an important role within a diversified portfolio due to their negative correlation to equities, lower volatility and relatively secure income stream.
“With higher interest rates anticipated in the future (albeit in the medium-term future), how do we alter our bond exposure to minimise interest rate risk? Firstly, we reduce the duration of the bonds that we hold. In other words, we reduce the time to maturity of the bond, and therefore reduce its sensitivity to interest rate rises. Secondly, we hold index-linked bonds as their capital value and coupons are linked to inflation so, in broad terms, as inflation rises, so does the level of income received.
“Equities: a natural hedge against inflation
Our portfolios also tend to hold a variety of real assets, such as equities, because they have an intrinsic value due to the company’s tangible assets or intellectual value. Indeed, equities provide most of the capital growth within a portfolio, while also providing a built-in hedge against inflation. This is because, while companies are initially impacted by the higher price of materials, inflation-driven costs are ultimately passed onto the consumer in the form of higher prices. We can also be confident that dividend-paying companies will work to maintain or grow their dividends, and companies that reinvest for growth will continue to do so, to maintain investor confidence.
“If inflation is expected, and does not rise too rapidly, companies can adapt. A diversified portfolio benefits from having exposure to an asset class which can factor in higher inflation and benefit from it. When selecting equities, either directly or via collectives, we ensure that we invest our clients’ money in high quality companies which have experienced inflationary periods, and have proven that they can manage these conditions.
“Inflation, which rises rapidly, will tend to take both businesses and consumers by surprise. However, our expectation is for a moderation of inflation towards the Bank of England’s target rate of 2%. In this environment, a well-diversified portfolio remains one of the best ways to protect wealth against rising prices, and we will continue to run our clients’ portfolios accordingly.”
Nick Leung, Research Analyst at WisdomTree, said: “Pound weakness was a key driver of last month’s uptick in UK CPI, falling to fresh lows against the euro and triggering a higher-than-expected increase in the import bill for UK consumers and businesses alike.
“This will likely encourage the Bank of England to refrain from tightening too soon, especially with UK economic activity looking fragile on the back of Brexit-induced business sentiment uncertainty and weakness in the construction sector.
“Until greater clarity emerges on the direction of Brexit negotiations, the rate hike cycle will likely be delayed for as long as possible, and ongoing political uncertainty will continue driving volatility in the pound and UK inflation.”