Inflation is on the lips of every policymaker and economist, with most attempting to settle investors’ nerves by offering assurances it will be a relatively short-lived phenomenon. That may be the case in most of the world, but it could prove stickier here in the UK.
To be clear, longer-term, my team and I are
very much in the deflation camp, but we cannot ignore the risk of wage inflation.
Prices in the developed world, where Covid-19 vaccine roll-outs have been hugely successful, are rocketing faster than anticipated.
Recent numbers make for startling reading, particularly in America where inflation hit
5.4 per cent in June – the largest spike since 2008. UK data are not yet as disquieting. The consumer price index rose 2.5% in June, albeit that this was the highest point since August 2018 and up on analyst forecasts of a 2.2% rise.
Given that a return to the runaway inflation
of the 1970s is unlikely, the key issue is not the actual numbers but their persistence. Equity
and bond markets would have us believe inflation will be fleeting.
They expect it to overshoot the Bank of England’s 2% target for a few months as economies reopen, readjust and recover from
the pandemic. When the economy returns to normal, so too will inflation.
So says the theory and it is probably right, but with a notable challenge in the UK – immigration. Brexit has fallen below the radar of most investors, with news coverage of Covid-19 masking changes to immigration policy.
While immigration in terms of official net numbers may not change markedly from pre-Brexit levels, the nationalities of those living and working in Britain stand to have altered dramatically.
When we opened our doors to workers from eight former communist states in central and eastern Europe in 2004, it heralded a huge transformation of our economy and society.
Now, data suggests net migration to the UK from European Union countries has reversed, plummeting in the wake of the referendum in 2016 as some immigrants questioned our hospitality, and tumbling further amid the coronavirus crisis as their jobs disappeared.
This stands to have a profound effect on certain sectors of the economy, specifically
those that tend to attract unskilled and low-paid workers – hospitality, travel and agriculture – as well as blue collar jobs for the like of plumbers, joiners and electricians.
Compounding this is a dearth of apprenticeships in the UK as a string of economic lockdowns
take their toll and the traditional trades skills
gap swells as more youngsters pursue office jobs or going to university.
As the economy reopens and businesses recruit staff to meet demand, competition for quality labour could act as another tailwind for wage inflation.
It has been stagnant in the 12 years that have followed the financial crisis, arguably owing to the influx of cheap labour from Europe.
The prices we pay for eating out or making home improvements have been subsidised for years – not by the government but by those on lower wages. While consumers may bemoan
the rise in costs, wage inflation for less-skilled labour is a good thing – both morally and for
Wages in the public sector are rising, too.
NHS staff in England have been offered
a 3% pay rise, backdated to April. The Government says that will boost the bank balance of the average nurse by £1,000 a year and hand an extra £540 to many porters
Against this backdrop, the case for “higher for longer” inflation in the UK is clear. We may see prices rising by 3-3.5% per annum over the next 12-24 months.
The exact numbers matter less than the trend and the impact it has on company margins and sentiment towards inflation, both of which are relatively negative for investors.
In positioning our portfolios accordingly, we have greater exposure to stock markets in the
US and Europe, where we see inflation as less
of a risk than it is here. We also have little exposure to UK bonds, where we view the rewards as scant compensation for the level of risk, again preferring issuers in the US, as well
as Canada and Japan.
Lastly, we have been adding to commodities. The UK is susceptible to cost push inflation from rising commodity prices and one way to mitigate this is to hold a range of commodity baskets.
David Coombs is head of multi-asset investments at Rathbones.