Is the UK’s bout of inflation a temporary condition or something more serious? Either way, investors and wealth managers should ready themselves for challenging times to come.
UK inflation is expected to hit 5% next spring. The Bank of England thinks it will then begin to fall, coming close to the target of 2% in two years’ time. Even so, the annualised rate of inflation for 2022 will likely be higher than it’s been for more than 30 years – since Black Wednesday, when the country was forced from the European Exchange Rate Mechanism.
Inflation can be catastrophic, so it’s welcome news that independent economists seem to agree that the Bank is approximately right. This isn’t a permanent shift, they say, though risks remain.
“In the sense that the forces that are initially causing the inflation are temporary, I think that’s a fair point,” says Rory MacQueen, principal economist at the National Institute of Economic and Social Research. The institute forecasts consumer prices index (CPI) inflation of 4.4% next year and 3.4% in 2023 before getting back below target in 2024, conditional on base rate rises in 2022 and 2023. It forecasts annualised GDP economic growth of 4.7% in 2022.
Over at Capital Economics, chief UK economist Paul Dales agrees that inflation is a temporary concern. Interest rates will top out at about 0.5% at the end of next year, he thinks, while “fairly soft” economic activity will help inflation drop to around 2% at the end of 2022. “Moderately higher interest rates are unlikely to derail the economic recovery,” says Dales.
So far so good. However, MacQueen points to a wage-price spiral as cause for concern.
“If we see everyone pricing expectations of inflation into their future plans, theoretically it could be a self-fulfilling inflation, in which temporary factors lead to permanently higher inflation.” However, this isn’t his think tank’s central scenario, he notes. “We think the bank will take enough action to bring it towards target, though perhaps not as quickly as some would like.”
Behind the curve?
Not everyone is so sanguine. Ruth Lea is an economist and economic adviser at Arbuthnot Banking Group. She is critical of the Bank of England’s failure to raise rates in November and worries they may have fallen behind the curve. “They have to start signalling that they’re going to hold back on some of the wilder excesses of demand in order to get to grips with what could become embedded inflation,” she cautions. “If inflationary expectations do get embedded then he [Governor Andrew Bailey] might have to put [rates] up by more, and in the meantime, don’t forget fiscal policy is still pretty generous.”
But how much freedom does the Bank really have? …….