Whatever central bankers say, the world is experiencing a ‘profound deflation pulse’

14th November 2013


Investment experts say that central bankers have no choice but to pretend that their policies are working but their real fear is deflation despite the hawkish words from the Bank of England this week.

Kames Capital’s head of multi-asset Scott Jamieson says: ‘There is great desire among central banks to suggest that their dramatic actions of recent years are bearing fruit. This week’s Inflation Report, published by the Bank of England, provided the latest platform for bankers to highlight that economic conditions are improving. Based on recent data this can hardly be denied  and many will find it plausible that the much discussed threshold for changing policy – an unemployment rate of 7% – will now be reached by the end of next year – much earlier than previously expected. However, investors would do well to remember that today’s forward guidance – narrative is pretty much all the central banks have to play with – quickly becomes tomorrow’s fish and chip paper.

‘The reality is that while jobs have been created they are not as they once were. Household disposable income continues to fall in real terms and the world is experiencing a profound deflation pulse; even the UK is seeing surprising declines in inflation. The idea that monetary policy will do anything other than loosen is ludicrous. This summer and during the tapering debate, Japan and the US together added nearly $500,000,000,000 to their joint monetary base. This is chaotic policy formulation. Central bankers have no option but to pretend it is working.’

Nick Hayes, manager of the AXA WF Global Strategic Bonds fund said: “Hawkish report, dovish talk, Gilts unchanged…. that for me summarises this week’s inflation report. As has been the case for the last number of years, markets are not only interpreting the economic data but also factoring in the extremely loose monetary policies from central banks. Taken in isolation you could be forgiven for thinking that the inflation report is pretty hawkish, and should lead to higher Government bond yields. With future unemployment levels falling faster than expected and higher expected GDP, “traditionalists” would be led to believe interest rates could be expected sooner rather than later, but as has been the trend in 2014, it’s what Central bankers say (aka “forward guidance”) that we are supposed to take notice of.

“And so it was the case yesterday, with the Bank of England at pains to point out that it is once we breach their unemployment level that they begin the debate for raising interest rates, rather than this being the trigger. As for inflation, well it’s still higher than target, and it’s still forecast to fall towards target. Not much new there! To me that still makes Government bonds look expensive, hence our short duration stance where possible. But in a world of improving growth and continued loose monetary policy, credit appears to be the attractive part of our asset class.”

David Dyer, senior portfolio manager at Axa IM says: “The main reasons for the downside surprise in inflation last month were clearly identified as university tuition fees, which have moderated after the large rise last year, and the notoriously volatile airfares component.  These however, could be dismissed as ‘one off’ effects.  In addition, the recently announced above-inflation energy price rises will feed through in the next few months.  With inflation also notably undershooting in the Euro area and Scandinavia, UK bond investors will be looking to see whether last month’s data is part of a wider disinflationary trend.”

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