X

Inflation will hit 4%, but rates won’t rise

  • Bank of England forecasts 4% inflation but is keeping rates and QE on hold
  • Bank outlines its exit plan for QE
  • Banks are ready for negative rates- but the world has moved on
  • Cash savers beware – inflation is expected to be over 3% this time next year and still over 2% in two years’ time

 

Laith Khalaf, head of investment analysis at AJ Bell, comments:

“Andrew Bailey better get his quill and inkpot out, because it’s looking like he’s going to be writing a number of letters to the Chancellor to explain why inflation is more than 1% above the Bank of England’s target. CPI has risen from 0.7% to 2.5% this year, and the Bank of England now expects it to rise to 4% at the end of 2021. Despite that, the Bank isn’t inclined to hike interest rates, or reduce QE.

“There is some method in the Bank’s madness. The utterly disruptive nature of the pandemic means the annualised economic data points we’re getting now are distorted by policy measures like furlough, combined with the extreme distress we saw in energy markets last year. They’re not so much a measure of where we are today, as how things stood last spring and summer, as the pandemic was at its worst. The Bank also has the ammunition to deal with inflation, by raising interest rates and QE, but there’s not much room for manoeuvre in the opposite direction if it needs to stimulate the economy because of another slowdown. It’s therefore likely to err on the side of being too loose with monetary policy rather than too tight.

“Of course that means we could be watching an inflationary spiral take off right before our very eyes if the Bank’s judgements on the transitory nature of price rises are wide of the mark. Even by the Bank’s own forecasts, sustained inflationary pressures are here to stay. The Bank forecasts 4% inflation at the end of this year, 3.3% inflation in one year’s time, and 2.1% in two years’ time. This will not come as welcome news to cash savers, particularly when the central bank is not raising rates. Taken together, those three inflationary figures would mean £100 in an account paying no interest being worth around £91 after 3 years. The household sector currently holds £240 billion in accounts that pay no interest, and are unlikely to until the bank raises rates. At least negative rates look to be off the table, even though commercial bank systems are now fully prepared to accommodate them after a six month preparatory period, which is a measure of how much the world has moved on in that time.

“The Bank of England has also outlined how it intends to unwind QE when the time comes. It will rely initially on simply not reinvesting the proceeds of maturing bonds in the QE programme, but won’t do this until interest rates rise to at least 0.5%. The Bank won’t actually sell any bonds until interest rates hit at least 1%. The Bank seems relatively sanguine about its ability to unwind QE in a predictable and gradual manner, and perhaps that is because it is focused on the direct effects on the UK economy. However the tightening of monetary policy and the unwinding of QE will have a big and damaging impact on the bond market and the public finances.

“The government currently pays bank rate of 0.1% on bonds held in the QE programme, so as base rates rise and QE remains in place, the Treasury’s interest bill balloons. The OBR reckons that a 1 percentage point rise in interest rates equates to £20.8 billion more in interest for the Exchequer in 2025/26. If inflation does take off, and interest rates rise, the Chancellor will have a big job on his hands to balance the books.

“The bond market is also highly susceptible to inflation, rising interest rates, and the unwinding of QE. For the last 12 years, bond prices have soared thanks to the continued activity of a price-insensitive buyer in the form of the central bank. This long-standing asset bubble could come to a nasty end when the QE engines into reverse, which will be exacerbated by the fact that those who buy bonds tend do so because they regard them as safe assets.”

Featured News

This Week’s Most Read

  • Is value investing coming back? For some of us it was never gone

    Reports of value investing’s demise have been greatly exaggerated… By Abdulaziz Alnaim, Portfolio Manager, Mayar Fund If I was given a dollar for every time someone told me that value

  • Is there a bull in the China shop?

    We bring you the views of two asset managers on China’s recent tightening of regulations. Mark Martyrossian, the CEO at Aubrey Capital Management, said: “The carnage wrought in several sectors

  • Brewin Dolphin grows investment solutions team

    Wealth manager Brewin Dolphin has grown its investment solutions team with the appointment of three portfolio analysts. The hires support the company’s successful build-out of its investment propositions for advisers,

  • Welcome to the Wealth DFM Podcast

    Wealth DFM Magazine is delighted to launch our latest podcast. In this insightful episode Sue Whitbread, Editor of Wealth DFM Magazine, sits down with two of Legal and General Investment

  • M&G Investments: Why the Bank of England should lead the tightening cycle

    By Richard Woolnough, M&G Investments As bond investors we constantly focus on economic growth, inflation, and interest rates. In order to understand the potential moves in the above we focus

  • Brooks Macdonald full year results show strong strategic progress

    Brooks Macdonald Group plc today announces its audited results for the year ended 30 June 2021. Financial highlights Group FUM reached record level of £16.5 billion (up 20.3% on FY20)

  • The new reality: every client is an ESG client

    In Invesco’s recent survey, nearly four out of five (79%) investors declared that sustainability is important to how they invest. More than half (52%) of those not already investing sustainably

  • Why companies in India are increasing their focus on sustainability

    By Vinay Agarwal, director and portfolio manager at FSSA Investment Managers, part of First Sentier Investors. In our view, several factors make India an attractive market to invest in over

  • Supply chain problems hit Primark as it hints of a new digital future

    Hargreaves Lansdown’s Susannah Streeter discusses the outlook for fashion chain Primark. Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, comments: “For now Primark is still firing on all

Wealth DFM