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Will ultra-low inflation push the FTSE 100 through the 7,000 barrier?

Against a backdrop of ultra-low inflation the FTSE 100 has hit a 15-year high and expectations of it finally breaking through the 7,000 mark in 2015 are rising.

The blue-chip index closed on 17 February at 6,898, just a short distance off its record closing level of 6,930, which it achieved on 30 December 1999. Yesterday the index posted a record 6,949 at closing.

After recording a mere 1 per cent aggregate gain in 2014, since the start of this year the index has already increased by 5 per cent. Given the steep fall in the cost of living, primarily on the back of the drop in the oil price and cost-cutting at supermarkets, optimism is high that further gains are set to come.

Official numbers show that UK inflation as measured by the Consumer Prices Index plummeted to its lowest level on record, hitting just 0.3 per cent in the year to January 2014 versus 0.5 per cent in December.  

While the oil majors and associated industries are feeling the pinch of the lower energy costs, a wealth of industries are set to reap the rewards of cheaper fuel – especially if the consensus forecast of prices staying lower for longer proves to be correct.

Hargreaves Lansdown senior analyst Laith Khalaf believes the FTSE 100 could breach the 7,000 mark in 2015, although the upcoming general election could cause turbulence for UK stocks.

He says: “If we see company earnings rising on the back of a lower oil price and confidence remains at current levels then it should be achievable. The improving economy, low interest rates and low inflation provide a positive backdrop for UK companies.”

Axa Wealth head of investing Adrian Lowcock says the low cost of living could prove a major fillip for UK stocks. He says: “On the back of the current backdrop of ultra-low inflation, the knock-on impact on stocks could be that the FTSE 100 finally pushes through the 7,000 mark this year for the very first time. Transportation and manufacturing costs should feel the benefits of cheaper oil feed through over the coming 12 to 18 months. This could well be the driver that pushes the market higher.”

In its latest quarterly inflation report, the Bank of England admitted inflation is likely to turn negative in the coming months and would remain close to zero for the rest of 2015. The Bank anticipates CPI will rebound and return to its two per cent target in two years, and subsequently edge slightly higher.

BoE governor Mark Carney says the risks of a deflationary slump are minimal and investors should ultimately not expect inflation to be low for long. Indeed, the oil price has already started to recover, with WTI trading at more than $52 while Brent has moved higher still to over $61.

The Bank’s overall outlook was upbeat, with Carney revealing it had raised its forecast for UK economic growth in 2016 to 2.9 per cent, up from 2.6 per cent.

The news from the ONS that unemployment fell to a six-year low of 5.7 per cent in the three months to December should also boost confidence. Meaningful wage growth is also beginning to filter through to the economy, with average weekly earnings (including bonuses) rising by 2.1 per cent in the final quarter of 2014.

Given the current environment of meagre inflation, the Bank of England is under no pressure to hike rates. As such loose monetary policy, which has already helped stocks rally since the nadir of the financial crisis, is set remain present for the time being. Carney has even suggested the cost of borrowing could even be cut further from its already historic low of 0.5 per cent if weak inflation, or deflation, persists.

Khalaf says despite the recent rally the FTSE 100 remains 50 per cent cheaper than it was at the end of the last century. He says: “The current P/E of the UK’s largest companies currently sits at 16 times earnings. This compares with the dizzy heights of almost 30 times earnings reached in December 1999. The long-term average is 15 times earnings.”

Khalaf insists investors should not be spooked and tempted into selling. “The headline index does not tell us anything about how stock prices relate to company earnings, it is therefore a bit like a clock face without any hands,” he says. “When you factor in company earnings, the UK stock market looks close to its long-term average.”

Looking ahead, Lowcock admits in the short-term the direction of stocks is likely to depend on a resolution with Greece being reached. In addition, low inflation could mean some companies struggle to raise prices and therefore profits. “This year is likely to be a stock pickers market,” he says.

Fidelity Worldwide Investment associate investment director Maike Currie recommends those who feel the current rate of inflation is uncomfortably close to deflation, and want to shield their portfolio against this threat, should look for firms with strong brands which benefit from pricing power.

“Companies that have a unique product and strong brand will be in a better position to increase prices regardless of the broader economy.”

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