Inflation starts 2021 without a bang


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Inflation has started 2021 in much the same vein as it finished 2020, low and moving sideways. The fact that restaurants and hotels provided a large upward pressure on CPI, despite largely being shuttered in January, provides ample cause for caution when interpreting broad economic indicators in a world where activity has been so horribly distorted by lockdown.

The January price variation of some common food items like cauliflowers, crisps and fishfingers suggests there may have been some temporary Brexit disruption at play too.

While the headline CPI rate is glacially cool, the debate between inflation and deflation is raging. Commodity prices have been creeping up, and the market seems to be buying into a global economic recovery, with cyclical stocks performing well. Combined with the huge amount of monetary and fiscal stimulus pumped into the economy, that suggests that inflationary pressures may be brewing.

However, the deflationary argument is also compelling. Unemployment is set to rise, global governments are going to have to raise taxes to pay back their massive debt mountains, and technology is going to continue to push costs down. On top of that sterling has been on the charge, which reduces UK import prices and hence keeps inflationary pressures at bay.

In the short term it’s pretty nailed on that inflation will rise quickly towards the Bank of England’s 2% target in the coming months, as the big energy price drops of spring 2020 start to get lapped by fresh data and the temporary VAT cut for hospitality and leisure businesses expires in April. That all coincides with the anticipated lifting of the current lockdown, when price collection will start to more accurately reflect normal activity.

Beyond that the crystal ball is particularly cloudy, which is problematic, seeing as inflation and deflation pose very different risks to savers and investors. But the burden of proof currently lies with those who think rising prices will be a problem, because the last decade of ultra-loose monetary policy has failed to coax the inflation genie out of the bottle.

For the moment market prices imply no movement in UK base rate over the next year, suggesting that inflation will remain under control, and the Bank of England won’t face pressure to tighten policy.

However even if inflation is contained at 2%, the interest currently being paid on cash mean that most money in the bank will be losing its buying power. Seeing as wealthier Britons have stashed so much away over the course of repeated lockdowns, that should be supportive of UK asset prices, in particular residential property and equity markets.

These articles are for information purposes only and are not a personal recommendation or advice.

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Written by:
Laith Khalaf

Laith Khalaf is a Financial Analyst at AJ Bell. He began his financial services career in 2001 at Hargreaves Lansdown, where he worked a variety of roles across pensions and investments, covering both DIY and advised business. Laith began to focus on research and investments in 2007, becoming a leading industry commentator. He’s provided daily business bulletins on LBC, is a regular contributor to the financial pages of the national press, and a frequent guest on TV and radio. He has a degree in Philosophy from Cambridge University.