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WeekWatch -‘Bank of England’s chief economist Huw Pill told the Financial Times inflation was likely to rise to around 5% early next year’ Oct 2021

WeekWatch -‘Bank of England’s chief economist Huw Pill told the Financial Times inflation was likely to rise to around 5% early next year’ Oct 2021

Global markets continued their recovery last week, even as the Bank of England suggested an announcement of increasing UK interest rates could happen in the next two weeks. In the UK, inflation dropped to 3.1% in September, compared to 3.2% in August. However last week the Bank of England’s chief economist Huw Pill told the Financial Times it was likely to rise to around 5% early next year.

He also gave a clear indication that a rate rise announcement could be made as early as the Bank’s Monetary Policy Committee meeting on 4 November, describing the situation as finely balanced.

These comments followed a speech from Andrew Bailey the prior Sunday, in which the BoE chief said the central bank would have to act to keep a lid on inflation – widely interpreted as a comment on a potential rate rise.

Markets did not react in a panicked manner to these statements, however – the FTSE dropped just 0.24% over the week. Part of the reason for this – as Martin Hennecke, Asia Investment Director at St. James’s Place, notes – is because any increase in interest rates will be gradual and coming from a historically low starting point.

He said : “Central bankers and governments will probably have to toughen their language somewhat soon, though; and at least be seen to take inflation seriously, if not launch some actions here or there – if small ones – to maintain the impression that there is no reason to worry much about inflation… simply because if they didn’t, sovereign yields – and thereby government refinancing costs – would likely rise significantly.”

That said, Hennecke warned investors to be mindful of growing inflationary risk when considering their investment decisions: “Investments that can provide protection from inflation over time include any type of physical assets, of course, but also the asset class of equities as well – noting that companies with an edge in the market will typically be passing on rising costs to customers in the form of higher prices charged for their goods and services… though passing on of costs may not always happen in a linear way, and clearly equity prices can still be volatile and subject to correction risks.”

As companies look to combat inflationary pressures, an increasing number have either begun to pass on these costs to consumers, or have revealed that price rises are likely in the future – including Unilever and Akzo Nobel (the parent company of paint brand Dulux).

According to Mark Dowding, chief investment officer at BlueBay Asset Management, there is currently some room for price increases for consumers: “With rising prices, sentiment indicators have stalled somewhat recently, but the consumer continues to spend, as highlighted by US retail sales last Friday showing 12% year-on-year growth and Chinese retail sales outperforming expectations. This indicates that, for now, companies have the power to pass on higher prices to consumers, and so those prices are more likely to show up in inflation, rather than impacting corporate margins.”

This has been reflected in recent company results, with several companies beating earning expectations over the past week.

Strong earnings helped lift US and European markets, with the S&P 500 breaking its own record high by Thursday. The Nasdaq Composite and STOXX Europe 600 both finished the week up, although neither quite reached the historic highs they hit earlier in the year.

While this is all positive, investors need to remain wary of the challenges that continue to exist. Supply chain issues continue to be a problem, with the chip shortage especially affecting a wide range of companies. On Friday, for example, Renault revealed it will produce at least 300,000 fewer vehicles this year as a result of a shortage of components. These shortages may well continue into 2022.

At the same time, COVID-19 numbers are continuing to rise in the UK, and energy prices remain high, adding to issues with supply chains; while the Chinese property industry remains brittle following the struggles at Evergrande, which only narrowly avoided a default last week.

With equity prices rising in the face of a number of potential challenges, diversification is likely to play a key role in achieving long-term returns, as different sectors come under different pressure, and at various times.

BlueBay is a fund manager for St. James’s Place.

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