UK Inflation Expectations: Seizing The Tiger’s Tail

Inflation has become a hot topic. Friedrich von Hayek likened controlling it to catching a tiger by the tail. Are UK investors making a grab for this least friendly of cats?

As Bank of England chief economist Andy Haldane tells it, “for many years, the inflationary tiger slept,” though now the “combined effects of unprecedentedly large shocks, and unprecedentedly high degrees of policy support, have stirred it from its slumber”.* Like any good economist, however, he hedges his bets, as “it would be spuriously precise” to assign probabilities to either inflationary or deflationary outcomes. That doesn’t stop the Monetary Policy Committee, on which Haldane sits, estimating a one-in-three chance of inflation lying below zero, or above 4%, at its two-year policy horizon. Perhaps this is the committee’s idea of ‘validly imprecise’.

Spend, Spend, Spend

Since the fourth quarter of 2020, the inflationary drums are beating loader. Broadly, a recovery from COVID is expected to unleash pent-up demand, as we all rush out on holiday, get our hair cut and gorge on restaurant fayre. Asset prices have bounced back, the most dramatic example being that of oil, where WTI Crude went from almost -$37 a barrel in April 2020 to above $60 and climbing.

Then there is the vast government spending to support the economy. The US has spent 30% of US GDP on COVID support, compared to 5% in the aftermath of the global financial crisis. And, of course, there’s more to come, with the US rolling out a $1.92trn recovery plan.

However, this side of the pond, there’s not much sign of inflation yet, as you can see from chart 1. It’s ticking up, but from a very low base.

Chart 1: UK CPI Inflation, February 2016 to February 2021

Source: Refinitiv Eikon

Bad for Bonds

Finance professor Jeremy Siegel, writing in the Financial Times, warned “higher inflation is coming, and it will hit bondholders”. Inflation reduces the real value of fixed income streams, so is bad for bond investors. “It will be the Treasury bondholder, through rising inflation, who will be paying for the unprecedented fiscal and monetary stimulus over the past year,” said Siegel.

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