ETF issuers comment on UK inflation data

Mar 20th, 2018 | By | Category: Fixed Income

Inflation in the UK fell more than expected during February, according to latest figures from the Office for National Statistics (ONS), providing some relief for hard-pressed consumers.

Consumer Price Index CPI Inflation

The UK’s Consumer Price Index was up 2.7% in February compared to a year previously, reflecting that inflation has fallen by 40 basis points since its high of 3.1% in November 2017.

The ONS reported that the Consumer Price Index – a measure of changing consumer prices – was up 2.7% compared to February 2017, one percentage point below where consensus analyst estimates thought it would be.

According to analysts, the surprise result reflected softer energy prices and base effects from sterling’s depreciation last year.

While the reading is still above the Bank of England’s (BoE) inflation target of 2%, this represents a move in the right direction following inflation’s recent high of 3.1% set in November.

Following the release of the inflation statistics, representatives from ETF issuers offered their take on what the results mean for UK monetary policy.

Nick Leung, research analyst at WisdomTree in Europe, notes that despite the downtrend, inflation remaining stubbornly above the BoE’s 2% target will “continue to drive up expectations for tighter monetary policy over coming months.”

He said, “Adding further pressure too will be the recent Brexit transition agreement, which now puts the UK economy on sounder footing to absorb higher interest rates and will likely represent an important component in the Bank of England’s path to policy normalisation.”

Tom Stevenson, an investment director at Fidelity International, also thought the inflation figures will put further pressure on the BoE to raise the base rate from its ‘emergency’ level in due course. While Stevenson thinks this is unlikely to be enacted when the monetary policy committee meets on Thursday, he believes the odds look good for a May rate hike.

He said, “Although the Bank now joins the Federal Reserve on a tightening bias, rate hikes will be lower and slower as long as the UK economy faces the uncertainty of the ongoing Brexit negotiations. The agreement of a 21 month transition this week is a step in the right direction but there remain many unanswered questions. Because of this, the Bank will stay cautious and the gap between US rates and those in the UK will widen.”

Perhaps staying the BoE’s hand at the upcoming meeting is that wage increases in the UK have remained stubbornly low despite a tight labour market, although this is expected to change further in the year. Although currently elusive, wage growth may be the last piece of the puzzle that unlocks higher interest rates.

Although consumers will be relieved to see the rate of price increase moving lower, the fact that inflation still sits above target highlights some considerations for savers given that interest rates still remain virtually negligible.

James Norton, a senior investment planner at Vanguard, explains, “Although we expect inflation to fall back towards 2.0% over the next couple of years, cash isn’t the safe-haven that many people believe it to be. Cash has an important role for everyone, to cover emergencies and unexpected expenses, but its value is falling year on year due to inflation.

“Those holding sufficient cash to cover 3-6 months expenditure should consider investing some of their hard-earned money to protect their long-term finances.”

In this regard, investors may wish to consider inflation-linked bond ETFs which provide investors with an inflation hedge as the principal of these issues increases with inflation and decreases with deflation, as measured by the Consumer Price Index.

Investors could also look at ETFs that invest in short-duration investment grade corporate bonds which offer a premium for taking on the credit risk associated with corporate debt. But by investing in shorter maturity bonds, investors are less exposed to duration risk – an increasingly important consideration as central banks look to normalise rates in the future.

Lastly, commodity ETFs, especially those linked to hard commodities, have historically provided a good hedge against inflation. Commodities in general may also be used to diversify portfolios.

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