Inflation predictions for 2017

November 3, 2016

This week the National Institute of Economic and Social Research (NIESR) forecast inflation to hit 4% in the second half of 2017. Our investment team take a look at the impact this could have on portfolios:

For economists there has been an expectation that it would reach at least this level in the short term given the change in currency as well as the oil price stabilising. This is a key reason while some investors have some focusing on shortening the duration of fixed income holdings. Even if the BOE may not raise rates any time soon, longer duration bonds will see their yields rise as investors holding them fear for their real value.

There are inflation linked bond funds on the market and these may be a potential antidote to higher global levels. Unfortunately, just buying index linked gilts opens up portfolios to greater risks as the duration is over 20 years and they tend to be very volatile. Equities and property will hopefully continue to provide a real return as well as a global currency exposure.

There is potentially a risk to the UK domestic economy from higher inflation, if wage growth fails to keep up. This would subdue consumer spending, which has been a primary driver of growth for several years. However, this may be more dependent on the Brexit negotiation result, and if it leads to job losses. The current tightness of the labour market should lead to wage growth above inflation in the medium term.

We don’t see 4% as a disastrous situation, in fact it is much more preferable to 0%. Inflation may bring back some animal spirits into spending and investing for both companies and individuals. With low inflation there is a strong incentive to take a wait and see attitude which has dogged the economy for a considerable period.

UK Sterling Inflation Volatility