Inflation & deflation Investment ViewPoints

28/01/2011 Markets hit the ground running in 2011 as the issue of inflation starts to rear its head. 09/09/2010 No news is still news… 30/03/2009 Deflation: what is it and can you beat it?

 

28 January 2011 - Markets hit the ground running in 2011 as the issue of inflation starts to rear its head.

 

We have had a fast paced start to 2011. As we near the end of the first month of the year, the markets have been active and already there are some clear economic themes beginning to emerge.

Using the FTSE-100 as a proxy for market performance so far this year, the Index looked as though it was steady above the 6,000 points threshold that it broke through at the end of 2010. A combination of early mergers and acquisition speculation, strong data from the US on jobs and manufacturing and a positive reaction to Eurozone bond issues, saw the FTSE-100 above the 6,000 mark everyday apart from three in the run up to 18 January. Its peak of 6,056 on 18 January was a two and a half year high.
 
However, weak earnings results from the US and poor UK unemployment data were then followed by strong Chinese growth numbers. This had a direct knock-on effect on the FTSE 100. The index lost a lot of ground, shedding over 180 points across 19 and 20 January. Despite a mild recovery, the index is now still languishing below 6,000.

After over two years of fiscal prudence from the UK government, with interest rates at historic lows, the inevitable threat of inflation is coming to the fore. The strong Chinese growth data was the real catalyst for the market pulling back; inflation fears arose as a direct consequence.

What is inflation?

Inflation n 1 a general rise in the prices of goods and services in an economy, which consequently leads to a reduction in the real value of money or the underlying spending power.

Inflation generally stems from economic growth so policy makers and governments must constantly try to achieve a balance between stimulating that growth but at the same time, keeping inflation in check. It can be a very fine balancing act.

Since the credit crisis in 2008 and the subsequent global recession, the key focus has been to reverse this trend and move the global economy back towards steady growth. Two key measures generally applied were the reduction in interest rates and the injection of capital into the economy. 

However, now those measures have, in most cases, successfully triggered growth, that growth has to be managed well. If inflation is left to escalate and develops into hyperinflation, then an economy can become “over-cooked” and the underlying value of money within that economy dwindles rapidly.

China and inflation

The release of positive Chinese growth data shows that the Chinese economy continues to strengthen, but it also heightens the risk of inflation. Although the Chinese Central Bank has already raised interest rates, on Christmas Day, the country may look to implement further inflation prevention.

How do we beat inflation?

The general concern amongst global markets is the fight to control inflation. Now that inflation fears are firmly on the Chinese economic agenda, they will begin to cascade through to everyone else. It seems inevitable that tackling inflation will be a key economic focus in 2011, the main question will be when and how policy makers go about it.

From a UK perspective, the unexpected news on Tuesday 25 January that the economy had shrunk by 0.5% as a result of the cold weather in late 2010, raised speculation that concerns about faltering growth might stem the onset of higher inflation, at least for a short period. However, subsequent comments on Wednesday 26 January from Mervyn King, the Governor of the Bank of England, asserted the view that inflation will continue to rise, with King forecasting a move to between four and five per cent in the coming months. King stated that the current rate of inflation, which stands at 3.7%, well above the bank’s target of 2%, has been driven by higher import prices due to sterling weakness, rising energy and commodity prices and the recent increase in VAT.

Investors concerned about the impact that inflation may have on their portfolios may wish to consider investment products that factor inflation into their performance.  For example the iShares Barclays Capital Global Inflation-Linked Bond (SGIL) is an Exchange Traded Fund (ETF) that that aims to track the performance of the Barclays Capital World Government Inflation-Linked Bond Index. The Index itself offers exposure to developed world government inflation-linked bonds issued in the domestic currency of each country.

You should bear in mind that the value of investments such as ETFs, which track inflation-linked bond indices, can go down as well as up and you may receive back less than you invest. You should ensure that you read and understand the full simplified prospectus for such products.

 

09/09/2010 - No news is still news…

At today's meeting of the Bank of England's Monetary Policy Committee (MPC), the decision was taken to maintain the base rate at its current level of 0.5%.  The MPC's call to hold rates static was widely anticipated, a case of no news is still news.  Most commentators have indicated that they feel it will still be some time before rates start to move higher again. With the inflation threat ever looming in the present economic climate, the current sentiment seems to be shifting in the opposite direction, even towards thoughts of further quantitative easing measures. As the Bank of England looks likely to hold interest rates at their current low levels until well into 2011, the challenge facing investors in trying to earn an income from their investments is magnified.  In our latest Investment ViewPoint: Analysis, we consider the different strategies available to investors looking to earn a crust from their investments. 

 

30 March 2009 - Deflation: what is it and can you beat it?

In recent months the global recession has taken hold and caused governments to resort to a range of measures to help breathe life into the global economy. Deflation has now come to the fore as a new threat to the recovery of the global economy. But what is deflation? And how can you spot and indeed take advantage of any opportunities that are in the market just now? This weeks ViewPoint considers the impact deflation could have on the economy.

Deflation is a sustained decrease in the general price level of goods and services that occurs when the annual inflation rate falls below zero %. Last week the UK Retail Price Index fell to zero, its lowest level in 49 years. If this trend continues the UK could be in for a period of deflation which is damaging to the economy as consumers adapt their buying behavior in anticipation of further falls in prices. This in turn can have a knock on effect on all sectors of the economy, particularly high street retailers and manufacturers who will, generally speaking, struggle to sell goods and services at normal market rates.

Change in prices in year to Feb 2009

 

So if things are so bad does that mean there aren’t any opportunities available to investors? How can investors ensure they make the most of their investments if deflation becomes a reality?

If you believe that deflation may have a significant impact on the future economic outlook, here are a few investment ideas that you may wish to consider:

 

• Fixed interest investments such as Bonds and Gilts benefit from deflation as they pay a set rate of interest known as the coupon. This will effectively become more valuable if deflation takes hold. Visit our fixed income site where you can find a range of bonds and gilts…..
• Earners – are stocks that pay a regular dividend which can be an added bonus when looking for an opportunity for selective stock picking. Of course in tough economic times there is downward pressure on certain firms to refrain from paying a dividend and use the assets of stock or cash to support the ongoing liquidity of the business rather than paying out to shareholders. The following are just some of the top Earners currently holding a strong buy recommendation from a panel of impartial market commentators based on their dividend yield.
• You can find these by logging in to the Research Centre.

Back to top