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John Chatfeild-Roberts: A little inflation can work wonders


A major reason why the equity market has been able to climb higher this year is that investors are not unnerved by the prospect of the Bank of England’s interest rate policy returning to normality. This is because the the catalyst for policy change is likely to be the resilience of the UK economy rather than a reaction to high inflation. To have some inflation (consumer price inflation is 1.9 per cent at present) can be helpful in that it gradually inflates away the outstanding government debt, invisibly spreading the burden of debt reduction across the whole population.

The improving health of the UK economy is also reflected in the recent strength of sterling.

Eurozone inflation looks to have held steady in June at 0.5 per cent, which is the lowest it has been in four years. There are tentative signs of the 18-state currency bloc at last delivering positive economic growth, but the recovery is fragile (0.2 per cent GDP growth in  Q1 2014) and help from the European Central Bank is required.

The ECB is concerned about the disinflationary forces now at work in Europe, which have been caused by the structural crunch of member countries trying to become more competitive through falling wages.Two historic drivers of inflation are bank lending and government spending, but unfortunately both of these have failed to accelerate.

Regulation now demands that banks hold more protective capital against their lending books, while lower government spending to improve finances has created a vacuum for economic growth.

The ECB announcements that have generated the most headlines recently are a negative deposit rate of minus 0.1 per cent for deposits held with the bank and the initiation of targeted long-term refinancing operations, which are designed to pass on cheap funding to small and medium-sized businesses. Time will tell whether the ECB has done enough at this late stage. 

The good news is that many European consumers now feel better off, despite falling wages, because of the strength of the euro. 

US consumers represent approximately 70 per cent of US GDP, according to the World Bank; consumer confidence is therefore crucial to the health of the American economy. The turnaround in the US housing market has proved a necessary tailwind to boost confidence. Improving home sales, falling mortgage rates and the recent slowdown in house price appreciation all bode well for an economy that looks set to get up speed again in the second half of this year after a harsh winter.

Geopolitical risks such as those associated with a highly combustible Middle East, worries about Ukraine and fears of a credit crisis in China could have given global investors good reason to be nervous but they have been pretty much ignored so far this year.

Equity markets are buoyant and volatility remains at historically low levels.

It might take a shake-out in the bond markets in response to further normalisation of extremely loose monetary policy by the US Federal Reserve for volatility to pick up. There remains plenty of potential in the world for catalysts to disrupt any extended market complacency.

In such times, it is by being aware of the changing environment and the opportunities that it presents, that we are able to stand ready to act for our investors.

John Chatfeild-Roberts is chief investment officer of Jupiter Asset Management 



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