Ernst & Young Item Club says inflation outlook higher than Bank of England expects

20th May 2013

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In a report that may be viewed with grim resignation by investors and savers, the Ernst & Young Item club has taken issue with the Bank of England’s relatively hopeful view on inflation.

The club has estimated that inflation will settle at 2.6pc in 2014 and 2015, contrary to the Bank of England’s expectations that inflation will meet the 2% target. As savers know, even such a small difference can have a significant erosive effect on savings and investments over time.

Issuing its special report on inflation, Peter Spencer, special economic adviser to the Item club said: “While inflationary pressures should cool in the Autumn, as domestic energy and food prices rise by less than they did at the same time last year, it’s unlikely that CPI inflation will dip below 2.5% before 2016. Meanwhile inflation as measured by the Retail Price Index (RPI) will remain above the CPI throughout the period, and start to accelerate away from CPI in 2015 and 2016 as housing costs increase.

“By the time the effect of rising university tuition fees drops out of the inflation calculation in late 2015, underlying inflationary pressures will be building again, as a stronger economy improves workers’ wage bargaining powers and firms’ ability to raise prices.”

Commenting on the report, Adrian Lowcock, senior investment manager at Hargreaves Lansdown, says: “A difference of 0.6% may not sound like a lot but over time it will have a significant effect.  Inflation at 2% will halve the value of your money in 35 years, but at 2.6% this falls to 27 years.  Forecasting inflation beyond the next couple of years is difficult particularly as the effects of quantitative easing are unknown.  Printing new money should generate inflation but there has not been any noticeable signs yet. To compound matters wages are not rising as fast as inflation.”

“Whether inflation is 2%, 2.6% or higher beating it over the longer term should be the number one priority for all investors, whether they are looking for income or growth.  As rates offered on cash and government bonds are close to record lows and offer below inflation returns investors are taking on more risk in the search for income.”

Hargreaves Lansdown has suggested three funds that may help investors cope.

Recommendations

Artemis Income –  The UK government may be struggling with its balance sheet but there are many examples of companies which are in rude financial health.  Adrian Frost and Adrian Gosden continues to look for companies with healthy cash flows where the long-term potential for dividend growth is strong.  The fund currently yields 3.9%.

Jupiter Strategic Bonds –  Predictions of a great rotation may have been overdone, with a yield of 5.4% there is still some attraction for investors in the corporate bond market.   However, a flow out of bonds to equities would impact on the capital value of the investment.  As such I prefer a bond fund where the managers, in this case Ariel Bezalel, has the flexibility to invest across the fixed income spectrum worldwide.

Newton Global Higher Income – We are seeing a move to quality within in global equity markets and companies that increase their dividends year in, year out, are highly prized by investors. They provide a rising income, which can be withdrawn if required or reinvested to provide a simple and powerful way to grow wealth. James Harries and his team at Newton have a superb track record and I believe this fund could be an excellent choice for long-term investors seeking to add an international flavour to their equity income portfolio. The fund has an historic yield of 3.98%.

 

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