No inflation bogey man lurking on the horizon

Rathbones’ head of asset allocation research Edward Smith looks at a number of inflation scenarios that we believe might play out over the next 20 years, and concludes that there is no reason to fear an inflation bogey man.

Our investment report Under pressure? looks at some of the major forces influencing the path of inflation over the longer term, and provides a number of scenarios that we believe might play out over the next 20 years or so. We hope these will be valuable tools for advisers as you help your clients plan for their financial futures.   
                                                                                       
Some of the structural forces that shape inflation are shifting in interesting ways, but the good news from our analysis is that the balance of evidence doesn’t suggest either a profoundly inflationary or deflationary environment is likely to emerge. In other words, inflation expectations look set to remain well anchored and under control.

The outcome we believe most likely is a benign scenario in which inflation expectations fluctuate only modestly around central bank targets and any inflationary effects of ageing or deflationary effects of technological change are controlled by monetary policy decisions. In this base case scenario, inflation stays in the 1.5% to 2.5% range across the entire 20-year period and we feel there is a 65% probability of this happening, i.e. almost a two in three chance. As we’ve noted in previous blogs on this subject, that should be good news for advisers and their clients – a more stable future is easier to plan for.

We see a period of technologically induced low inflation as the second most likely outcome – one that we believe has a one in five chance of occurring. This scenario covers a range of technological events that could each push prices lower and leave inflation within the 0.5% to 1.5% range over the next 20 years.

We give a very small probability of the final two scenarios happening, just 7.5%, just over a one in 13 chance. The first of these, secular stagnation, is characterised by a world that prefers to save rather than invest. It’s not a pleasant thought for the financial planning industry, but fortunately one we see as very unlikely to come to fruition. In this environment growth would be low, deterring new investments and new technologies would be hard to come by. Nominal interest rates couldn’t be set low enough, and inflation would fall to extremely low levels.

Policy induced stagflation is the final scenario and, in this one, low growth and frequent recessions combine with high inflation. Here, populist policies result in a dramatic rise in government spending and possible withdrawal of central bank independence which un-anchors inflation expectations. At the same time supply is constrained by protectionist policies that move globalisation into reverse. While this may all seem unlikely, the risk of such a scenario unfolding has certainly increased since President Donald Trump took office and the UK’s Labour party has surged in the polls while veering sharply to the left.

Of course the most appropriate long-term investment strategy will depend on the likely path of inflation. For instance, our research suggests that equities typically struggle when inflation falls below 0.5% or rises above 3.5%, while all assets other than gold typically perform worse when both inflation and growth expectations fall at the same time.

In our base case scenario, a balanced, multi-asset portfolio with equities at its core would be likely to have the best prospects for longer-term risk-adjusted returns. In contrast, equities in general are likely to underperform in the policy induced stagflation scenario, although investing in gold may be an appropriate strategy depending on how real yields respond.

Finally, as long-term investors, we are constantly on the lookout for investment themes that might provide a source of return irrespective of fluctuations in the economic cycle. We have touched on a number of such themes throughout our report — ageing, personalised medicine and automation, for example. If you would like more information on these themes, please contact your investment manager.

Visit Rathbone’s inflation hub where you can try our personal inflation calculator and read the full report Under pressure? for a deeper look into the economic themes driving long-term inflation.

 

 

 

 

Important legal information

This area of the site is for professional advisers

Please read this page before proceeding, it explains certain legal and regulatory restrictions applicable to the distribution of this information. It is your responsibility to inform yourselves of and to observe all applicable laws and regulations of the relevant jurisdiction.

This section of the website is directed only at investment advisers and other financial intermediaries who are authorised and regulated by the Financial Conduct Authority (FCA).

The information provided in this site is directed at UK investment advisers only and must not be circulated to private clients or to the general public. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

I confirm that I am an investment intermediary authorised and regulated by the Financial Conduct Authority. I have read and understood the legal information and risk warnings below:

Important Information (Terms and Conditions)

The information contained on this site is believed to be accurate at the date of publication but no warranty of accuracy is given and the information is subject to change without notice. Any opinions or estimates included herein constitute a judgement as of the date of publication and are subject to change without notice. Furthermore, no responsibility is accepted for the accuracy of any information contained within sites provided by third parties that may have links to or from our pages.

Rathbone Investment Management Limited ("RIM") is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered Office: Port of Liverpool Building, Pier Head, Liverpool L3 1NW. Registered in England No 01448919.

In accordance with regulations, all electronic communications and telephone calls between Rathbones and its clients are recorded and stored for a minimum period of six months.

The information provided in this site is directed at UK investors only. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

In particular, the information herein is not for distribution and does not constitute an offer to sell or the solicitation of any offer to buy any securities in France and the United States of America to or for the benefit of United States persons (being resident in the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof).

In order to comply with money laundering and other regulations, additional documentation for identification purposes may be required.

Rathbones shall have no liability for any data transmission errors such as data loss, damage or alteration of any kind including, but not limited to, any direct, indirect or consequential damage arising out of the use of services provided or referred to in this website.

Past performance should not be seen as an indication of future performance.

The value of investments and the income from them can fall as well as rise and you may not get back the amount originally invested, particularly if your client does not continue with the investment over the longer term.

Changes in the rate of exchange between currencies may cause the value of an investment to go up or down.

Interest rate fluctuations are likely to affect the capital value of investments within bond funds. When long term interest rates rise the capital value of units is likely to fall and vice versa. The effect will be more apparent on funds that invest significantly in long dated securities. The value of capital and income will fluctuate as interest rates and credit ratings of the issuing companies change.

Tax levels and reliefs are those currently applicable and may change and the value of any tax advantage will depend on individual circumstances.

Investing in emerging markets or small companies may be potentially volatile, as these investments are high risk.

The design, text and images are owned, except as expressly stated by members of the Rathbone Group. They may not be copied, transmitted, displayed, performed, distributed, licensed, altered, framed, stored or otherwise used in whole or in part or in any manner without the written consent of Rathbones except to the extent permitted and under the procedures specified in the copyright Designs and Patents Act 1988, as amended and then only with notices of Rathbones' rights.

Rate this page:
No votes yet