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THE INVESTOR
David Smith
Economist and author
Masao Yamazaki. Sources: 1 theice.com, January 2016-April 2016; 2 fao.org, January 2017; 3 ons.gov.uk, January 2017; 4 consensuseconomics.com, January 2017
T
wo years ago it
seemed as if the last
thing we would be
worrying about was
the return of inflation.
Consumer price
inflation in the UK was stuck at zero
while the eurozone was flirting with
falling prices.Time has moved on. Rising
inflation is now one of the stories of
2017, and it has a lot further to run.
The tide of inflation has turned for
three distinct reasons. First, a sharp fall
in oil and commodity prices was behind
the disappearance of inflation, and the
reversal of that fall explains much about
inflation’s return.World oil prices are
nearly double their lows in the early part
of 2016
1
, partly due to a strengthening of
the global economy and partly because
of production cuts by OPEC, the oil
producers’ cartel.Other commodity prices
have risen; the Food andAgriculture
Organization of the United Nations said
food prices in January, for example,
were up 16.4% on a year earlier
2
.
A second factor is that, on top of
a general strengthening of the global
economy and an easing of fears of a
so-called hard landing for China, the
election of DonaldTrump raised
expectations of stronger growth in the
US.A combination of his tax-cutting
agenda and a promised boost in spending
on US infrastructure seems likely to
stoke inflation as well as promote
stronger growth.
In the case of the UK, the third factor
is the pound’s sharp post-referendum
fall. Sterling has dropped by around a
fifth against the dollar since the vote
to leave the EU and this has pushed up
the cost of imports. In early 2017,
British industry’s raw material and
fuel costs were up by more than 20%
on a year earlier
3
.
How high is inflation likely to go? In
the case of the US, the consensus among
economists is that inflation will average
2.5%over the next two years, slightly above
the 2% expected for advanced economies
as a whole. Britain’s inflation rate, boosted
by that sterling fall, is expected to be
around 3%. Inflation in the emerging
economies is seen as rising to around 4%
4
.
What will this mean for investors?
The key question is how central banks
choose to respond.The US Federal
Reserve has already put markets on
notice for further interest rate hikes this
year and higher inflation will reinforce
this.The Bank of England, having cut
interest rates as recently asAugust, is
caught between‘looking through’ what
it might regard as temporarily high
inflation, and moving towards higher
interest rates.When the latter comes
about, it will be a significant moment: the
last rate hike was ten years ago, in 2007.
The big picture shows us moving past
the period of exceptionally low inflation
into something more normal.Any sign
that inflation is becoming more ingrained
than that should be watched attentively.
World events have led to a rise in inflation on both
sides of theAtlantic. Is it a blip or a trend?