As if their investment decisions are not difficult enough, fund managers have the added complication of deciding whether they are facing inflation or deflation.
Should investors be buying inflation protection? Alessandro Ghidini, fund manager at Swiss & Global Asset Management, says: “There is a lot of money around in the world, which could be inflationary.
The very reason it could make sense to protect real yield from inflation is that inflation is unpredictable.
Commodities still make up a big part of CPI baskets, and their prices are difficult if not impossible to forecast.
“Since in emerging markets commodities still play a big role, it can make sense to hedge your returns against what it is difficult to predict.”
François Savary, CIO at Swiss private bank Reyl & Cie, expects to see some inflation in the next six to 24 months.
“When you look at the numbers of 3% for Europe, considering we are currently in a low-growth environment, you ask yourself what will inflation be when we have more growth?”
In the UK last month, the inflation rate surged to 5.2%, from a little above 1% since the latter part of 2009, and well above the Bank of England’s stated target of 2%.
A steep rise in the cost of living suggests actual inflation is already much higher. This appears to contradict the claims by Bank of England governor Mervyn King that the challenge facing the UK is deflation, not inflation.
Bill McQuaker, deputy head of equities, Henderson Global Investors, says inflation has been on his mind ever since 2009 and the beginning of QE.
But, he says: “The picture is puzzling. If you asked economists what they would expect of the UK, with rising unemployment, the worst recession since the 1970s and slow recovery from it, I would bet they would not expect inflation at 4% to 5%, but it is.
I worry about looking too much, or exclusively, at the obvious data points because they can convince you that the picture is more benign than perhaps it actually is.”
David Miller, partner at Cheviot Asset Management, commenting on the surge in the UK’s consumer and retail prices indices, said: “This is not a re-run of the 1970s,” despite the CPI at 5.2% in September, the highest figure ever for this measure, and the Retail Prices Index at 5.6%, the highest in over 20 years.
“The figures show inflation is being driven by the rising cost of transport, housing and household services, and food, which between them account for over half of all inflation.”
He added: “Britain is not going back to the days of endemic high inflation. While these numbers are slightly worse than expected they are not shocking. If you strip out higher taxes, energy bills and food prices, Britain’s inflation would be about the same as Germany’s. As these factors work their way out of the equation over the next year we can expect to see inflation coming down.”
Ulrich Kater, DekaBank chief economist, expects neither “severe inflation nor deflation” in Germany or the eurozone in the short- or medium-term.
He forecasts 2.5% towards December, then near the ECB’s 2% target in mid-2012. DekaBank foresees 2.6% this year, 2.1% in 2012, and 1.7% in 2013.
Will heightened ECB monetary policy fuel inflation? No, says Kater. “The billions of cheap ECB-money do not reach the real economy through bank lending at an alarming scale, but are absorbed by the ECB, and hoarded by banks on their central bank accounts.”
Carolus Reincke, director portfolio manager FIM in Finland, says: “The problems we have in Europe with the balance sheet issues of countries and sovereigns is inherently deflationary.
But the solution to the problem will most probably be inflationary, such as, printing money. In the short term there is perhaps deflationary risk, but long term definitely a more inflationary environment.”
Reincke adds: “Inflation for equities is a good thing because companies historically have been able to push through the inflation effect to their customers. Equities in this environment are our preferred asset class, along with, for example, commodities.”
Patrick Rudden, manager of AllianceBernstein’s Dynamic Diversified Portfolio, says: “There is a Keynesian thought that we have slack in the economy in terms of unemployment, so we will not get inflation. But the immense size of money we have just printed is always inflationary.
“The vast majority of the world is at above 5%, with notable exceptions of Continental Europe, the US and Japan. Sitting in the world’s financial centres, therefore, you are getting a view that is, in fact, a minority view.”