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Gilt trip

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A combination of higher inflation and a faltering economy should have been sufficient to push the stockmarket into reverse. Quite the opposite happened. Shares, while hardly running away, found support as confidence grew that the European debt crisis might somehow be kept under control. Of course, it is by no means certain that an accord will be reached. Concerns that a bridge between the German and French standpoints has yet to be built were sufficient to see our market hand back some earlier gains.

As it happens, some more encouraging news has been emerging from the US. There is evidence of stabilisation in the housing market and of job creation in manufacturing industry. It seems that continuing inflation in China is rendering their factories less competitive on the world stage while the growing affluence is seeing more of their output consumed domestically. It’s an ill wind…

But inflation is becoming an issue for a variety of countries. Our own figures were released last week and the expected rise was even greater than forecast. Higher gas and electricity bills were blamed and the Governor of the Bank of England stated that this should be the peak. It may indeed be the highest point reached in this cycle but I am not expecting a rapid return to near the Government’s target.

Underlying inflation is hard to gauge but with commodity and raw material prices holding up, it is unlikely that the decline will be that great. A two percentage point fall is probably the best we can hope for. Last month’s cost of living numbers are important because they set the increase for pensions and benefits in the year ahead. Catching the trend at a supposed high should help among the most needy in our society but at a significant cost to the Exchequer. That ill wind is blowing here too.

So if inflation is set to remain with us, why are gilts still so strong and the monetary policy committee ignoring the threat? The answer to the second part of this question can be found in the minutes of the MPC’s most recent meeting, also published last week. Whereas in September just one member called for a resumption of quantitative easing, by the time the next meeting took place, the committee was unanimous in sanctioning the printing of yet more money.

They, of course, had seen the latest set of statistics on the economy. Restoring growth has become a far higher priority than curbing inflation. Anyway, there is no reason to believe that an interest rate hike would have the desired effect. Inflation in this country is not being led by rampant consumer spending or excessive wage demands. While the VAT increase will shortly drop out of the calculation and help bring the rate of inflation down, the truth is that our policymakers have no control over the price rises that are being generated elsewhere as the emerging world competes for global resources.

So, notwithstanding the level of inflation, interest rates look likely to continue at their present low level for the foreseeable future. Our economy simply cannot cope with an increase, which would put further pressure on an already hard-pressed consumer. The Government would love us to spend our way out of the economic doldrums but dare not encourage us. No wonder gilts are holding up. It does not make them good value, though.

Brian Tora is an associate with investment managers JM Finn & Co

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