Morningstar's Inflation Forecast

In the UK, we are currently importing inflation as a result of sterling’s decline relative to our trading partners and a rebound in the price of oil

Daniel Vaughan, CFA 18 November, 2016 | 12:15PM
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Daniel Vaughan: There has been plenty of media commentry in recent weeks on the potential re-emergence of Inflation on both sides of the Atlantic. This marks a change in the headlines and also in market sentiment as developed economies struggle to escape from a low inflation environment despite significant central bank stimulus.

In the UK, we are currently importing inflation as a result of sterling’s decline relative to our trading partners and a rebound in the price of oil. UK inflation linked bonds have moved to price in inflation above 3%, which makes them look relatively unattractive to us now.

Despite a recent up-tick the most recent figures from the Office for National Statistics reported inflation dropped to 0.9% in October, undershooting consensus forecasts and the Bank of England target. Looking at inflation data going back to 1750 sub-1% inflation is by no means historically unusual.

Across the pond, US markets are also now anticipating inflation will head higher after Donald Trump’s election victory.  There is clearly the potential for “good” inflation arising from greater fiscal stimulus – Trump’s tax cuts and public spending programmes – while rental inflation, and rising healthcare costs, may also give support.

There is also speculation that it could head even higher if Trump follows through on campaign rhetoric to raise tariffs on Mexican and Chinese imports.

Inflation was already on the way up as economic growth has caused a tightening in the labour market generating up-ward wage pressure. US inflation linked bonds moved to price in inflation of around 1.9% after his win which looks fair to us.

We have been reviewing our inflation estimates.

Both the Fed and the Bank of England target 2% inflation, and our estimates have been anchored around central bank targets as given our long-term time horizon it is difficult to diverge significantly from central bank targets. However, we are assuming inflation modestly above these targets for the UK and US as policies are accommodative.

These assumptions are important as they underpin our fair-values and our valuation implied returns for equities and bonds. As always we will look to move our portfolio towards asset classes with the most attractive implied returns.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Daniel Vaughan, CFA

Daniel Vaughan, CFA  is a portfolio manager for Morningstar Investment Management