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Adviser Fund Index

Renewed debate over the Bank of Eng- land bank rate could prompt a rethink on asset allocations in the Adviser Fund Index portfolios.

A perceived shift in tone at the monetary policy committee’s January meeting has prompted uncertainty over its resolve to keep the bank’s base interest rate at its current 0.5 per cent in the face of continuing above-target inflation.

The Confederation of British Industry, said last week it expects consumer price inflation to average 4.2 per cent in the first three months of 2011. This would be more than double the bank’s 2 per cent target rate and put pressure on policymakers to start reining it back in.

For AFI panellists, the prospect of an early rate rise could start to have an impact on returns, particularly on fixed-income holdings. With inflation already outstripping yields on a number of investment-grade and sovereign bonds, the argument for buying into corporate debt at this stage in the cycle is looking progressively shaky.

Chartwell Investment Management head of fund research James Davies says: “We will not go to a zero weighting in inv- estment-grade but what we have done is move more into strategic bond funds where the manager can invest across the fixed- income spectrum. An uptick in rates would probably be a pretty bad shock for investment grade.”

Expectations for when this rate rise might materialise, however, remain divergent. Some predict the MPC will move as early as March while others suggest a May rate rise is a more likely scenario, although most expect a move by August.

This is not to suggest that consensus is overwhelmingly in favour of such a decision. Indeed, many panellists echo the findings of a research note issued by Bank of America Merrill Lynch last week, which suggested a premature rate risk could jeopardise Britain’s already weak econ- omic recovery.

Doubts over the validity of a hawkish analysis were further stoked by the release of figures showing Britain’s gross domestic product fell 0.5 per cent in the last quarter of 2010, according to the Office for Nat- ional Statistics. The Government blamed some of the contraction on bad weather but the statistics were worse than even the most bearish forecasts and gave weight to the MPC’s previous claims that the fragile recovery warrants a loose monetary policy.

Chelsea Financial Services managing director Darius McDermott says: “There is very little that British policymakers have left in their armoury to keep liquidity flowing so I do not see them moving on rates now. If inflation stays above target over the next few months, however, I would not rule out a small move by the end of the year.”

What is apparent from the coverage is that there is a lot of confusion over the issue. Part of this reflects the difficulties faced by the MPC from the competing pressures of inflation targeting and economic stability and part investors hedg- ing their bets now that a rate rise seems more plausible.

In both cases, too much reliance is being placed on relatively short-term figures, the consequence of which has been to obscure rather than clarify the underlying econ- omic picture. It ignores, for example, the fact that inflation has now been running above target since December 2009.

But with Bank of England governor Mervyn King stating that real incomes will stay flat across 2011 as individuals “pay the inevitable price” for the financial crisis, it seems that, for the moment, combating inflation is not his central concern.

Data supplied by Financial Express

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