2) Could war in the Ukraine alter our view?
Even if the price of oil were to rise by almost another 50%, the contribution to global inflation from energy would be half what it is today by the end of the year. Oil price futures, which already price some degree of Russian supply risk, suggest oil will be 10-15% cheaper at year end, and natural gas futures, which should be even more influenced by Russia, suggest prices will stay roughly where they are.
Futures aren’t perfect forecasters. But we note that when Russia annexed Crimea in early 2014, the resulting sanctions did not result in an oil price spike – Europe’s gas reserves would be depleted in six weeks if it turned off the Russian tap so it’s unlikely to put in place harsher oil-related sanctions. Pipelines could get damaged in a conflict, or Russia could turn off the taps at its end, in which case, with inflation already high, there is a risk that this joins the Yom Kippur War of 1973, the 1979 Iranian revolution, and the first Gulf war in 1990 as three of the only geopolitical conflicts to cause lasting disruption to the global economy. But it’s not our base case. Most geopolitical conflicts, for all the hot air, have no lasting financial impact.
3) What about elsewhere in the world. Is the British experience unique?
Broadly speaking, no. Inflation in the US is running even hotter. The annual rate was 7.5% in January. Apart from the three main drivers, there is a fourth reason why inflation has risen so sharply in the US that is less applicable to the rest of the world: unprecedented fiscal support during the pandemic that, after the event, could be judged as rather excessive – personal incomes actually rose incredibly sharply in 2020 in contrast to the rest of the world. This means that we’re seeing some broader price pressures, including in the services sector. We think our base case still holds, but there’s a significant risk that these pressures stay with us.
In most Eurozone countries, inflation is lower than it is in the UK. Inflation rates are annual rates of change, but we should also consider the two-year rates of change to look through the fact that prices fell sharply during the pandemic, so we can judge if there is something more broad-based and structural potentially going on. Those two-year rates are still below 2% in the Eurozone, in annualised terms, in stark contrast to the UK and US. It potentially puts Europe in something of a sweet-spot that attracts us as investors.
4) Many investors are concerned about wage growth spiralling higher. Are we?
This is the trillion-dollar question.
For today’s rates of inflation to persist, it requires, what is called in the jargon, a “wage-price spiral”, where employees demand ever higher pay increases, which they spend and therefore push up the price of goods, and then they demand even higher wages to pay for the even higher cost of goods, and so on.
In December, UK wage growth was actually lower than expected, at 3.7%. Wage growth has settled into a more normal range – even in sectors such as construction or hospitality. Surveys also suggest that we are well-past the peak in pressures caused by the availability of labour relative to the demand for it.
There is more pressure in the US. But even there, the rate at which people are voluntarily quitting their jobs has stabilised at a level consistent with wage growth easing back from 5.0% to nearer 4.5%. Similarly, the latest small business survey shows a drop back in the proportion of small businesses planning to raise worker compensation, which is also consistent with this dropping back. There are a confusing number of measures in the US, but our favoured measure of wage growth is at 3.9% and that’s where it was in 2019, and well below where it was in the 2000s.
Wage growth is likely to be more than the previous decade. Participation rates have dropped, unemployment is low. But it doesn’t look as though wage growth is likely to be much higher than it was in the two decades before that – and profits or financial markets didn’t buckle under that pressure.
