Who’d be a central banker today? Once, they were the masters of the universe, bravely slaying the dragon of inflation and slashing interest rates to save the economy in times of peril. Today, they seem powerless to control inflation. Fearful of raising interest rates too far, they issue hollow calls for wage restraint.
Just 12 months ago, the Bank of England was predicting inflation would be less than 2.5% today. In fact, it has just hit 9%, and the Bank expects it to exceed 10% by the year-end.
Of course, the war in Ukraine, soaring energy and food prices, supply chain disruption and the Covid lockdowns in China were all – to a greater or lesser extent – not easily predictable.
Transitory pressure?
But what really puzzles us is their forecast that inflation will fall back to the official 2% target by early 2024.
There are really only two ways for that target to be met. Either the Bank intends to raise rates high enough to plunge the economy into recession, or it is desperately hoping energy and food prices stabilise, supply chains are unblocked, deglobalisation is reversed and, most importantly, wages don’t rise.
Back in the real world, average earnings (as measured by the Bank itself) are already rising at 4-5%.
The good news is that unemployment is now just 3.7%, the lowest since 1974, and job vacancies are at all-time highs.
The bad news is that such a tight labour market points to rising wages. If earnings rise to offset the cost-of-living crisis, then inflation will become embedded in the system.
Unless the Bank is willing (and allowed) to raise rates dramatically, we struggle to see how inflation falls back to target by 2024. But will central banks and governments prescribe such harsh medicine? We think not.
Either official interest rate forecasts are wrong, or we are heading for a recession, though we could, of course, get stagflation – low growth and inflation. We think it’s more likely that inflation does not fall back to target any time soon. But, if it turns out to be a recession, we are prepared, with our portfolios’ credit protections likely to be particularly effective.
We expect central banks to conclude that inflation may be the lesser of these two evils. But investors should be in no doubt about the threat it poses.
Ajay Johal is an investment manager at Ruffer
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Ruffer LLP is a limited liability partnership, registered in England with registered number OC305288 authorised and regulated by the Financial Conduct Authority. The information contained in this article does not constitute investment advice or research and should not be used as the basis of any investment decision.
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