But chief investment officers (CIOs) maintain that the prospect of rising inflation in the near term should not lead to significant changes in funds’ investment decisions.
Data released by the Office for National Statistics shows consumer prices index (CPI) annual inflation dropped to 2.2% in September, down from the 2.5% recorded in the previous month.
CPI inflation is now at its lowest since November 2009.The fall was driven by September 2011’S utility bill rises dropping out of the annual calculation.
The Bank of England’s official CPI target is 2%. Mervyn King, the Bank’s governor, said earlier this year that “inflation is likely to fall further from its current level to be around or a little below target”.
However, economists predict that a number of external factors will cause CPI will to rise again in the coming months despite the fall reported yesterday.
September’s fall “as good as it gets”
Capital Economics’ chief UK economist Vicky Redwood claims the fall“is likely to be the last for a while”, although inflation should drop below 2% in the medium term.
“The recently announced utility price increases will add 0.1% to inflation for each of the next three months,” she explained.
“And food prices could start to rise as past commodity price increases feed through, while the rise in tuition fees will boost inflation in October.”
Howard Archer, chief UK and European economist at IHS Global Insight,said the fall in inflation will make it easier for the Bank to justify adding to its £375bn quantitative easing programme in November, as well as boosting consumer purchasing power.
However, he said: “This may very well be as good as it gets on the consumer price inflation for the time being, as we suspect it could be pushed back above 2.5% in the near term.”
Time to change portfolios?
Rathbones Unit Trust Management CIO Julian Chillingworth said the short-term rise in CPI inflation has been anticipated and does not demand a significant change in strategy, although some sectors will be more affected than others.
It remains unclear how the sharing of food price increases will be split between the consumer, supermarkets and food producers but Chillingworth argued that food retailers could come off worse.
“There is a thought that the food producers are in a much stronger position now when negotiating with supermarkets than they were,” he said. “Therefore, supermarkets may have to take abit of the pain on any inflation that’s coming through.”
In addition, Chillingworth pointed out that recent gas price increases will be positive for the profits of utility companies, even though this will have an adverse impact on consumer spending power.
Richard Jeffrey, CIO at Cazenove Capital Management, says the fact that CPI inflation has dropped significantly from its September 2011 peak of 5.2% bodes well for the economy overall.
“The most important aspect of the recent trend in inflation is that it is reducing the squeeze on household spending power – a squeeze that was particularly pernicious in 2011 and which continued to have an impact during the first half of 2012,” he said.
“This will help the economy return to a positive growth path both in the second half of 2012 and through 2013.”
Need for returns
For the end investor, however, the prospect of inflation again moving away from the 2% target could force them to take another look at fund selection.
Yesterday’s figures mean basic rate taxpayers will need to see a return of at least 2.76% for their investments to beat inflation in real terms, according to figures from MoneySupermarket.com. For higher rate taxpayers this rises to 3.68%, while those in the 50% tax band require a return of at least 4.41%.
Should CPI resume its upward trend – a risk that is largely out of policymakers’ control – even higher returns would be needed to offset inflation’s eroding effect.
