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Client Update - 30th April 2021

Inflation has been historically low in recent times, especially versus the levels experienced in the 70s and 80s. Following what has been a volatile year for markets throughout the pandemic and given unprecedented global central bank support to markets and consumers, inflation is back on the lips of investors around the world. We are beginning to approach an inflection point over the summer, where we will either see a sustained upward trajectory of prices or a petering out.

For the vast majority of the past year, the global population has been locked away in their homes, unable to spend as freely as they wish and whilst individual experiences have varied massively, households in aggregate have accumulated large amounts of savings. This has been compounded by the 'cautious consumer' – unsure of their future, so best to steady the ship and save – and by governments propping up incomes where necessary, through stimulus cheques or furlough-like schemes. As a result, consumers are wealthier than ever and there is a lot of pent-up demand. As economies continue to open up, consumers will be spending with optimism, spurred on by positive vaccine news, and this will drive prices higher.

Companies have been feeling the pinch of rising input costs, mainly driven by multi-year high commodity prices. Oil prices are up about 405% from a late April 2020 bottom, copper prices have increased 80% during that time and lumber has reached its highest price ever. This will no doubt impact the end consumer through higher prices. Procter & Gamble and Kimberly-Clark, to name a couple of global behemoths, have already stated they will be increasing prices later this year across a range of products to offset the increased input costs.

In the pre-pandemic world, companies had no real need to stockpile and inventory levels remained relatively low. Companies are now feeling that effect as they plan for the return to normality, with inventory shortages hitting the headlines. This will have been hampered by the blockage in the Suez Canal recently, slowing down production lines.

For example, as we have seen in the news this week, we are facing a 'global chip crunch'. The supplies of semiconductor chips, used in every electronics gadget, have been running low because of the increased demand for electronics during the pandemic and outages at large factories. The chip crunch has been worsened by aggressive stockpiling by Chinese companies, who are concerned about facing further sanctions from the US regarding China's 5G ambitions. This is now starting to seep across into other industries, affecting everyday items such as washing machines and toasters, and as supply tightens, price hikes are inevitable as companies try to offload their increased costs.

We remain of the view that inflation will hit around 3% or even higher at the start of the summer, before starting to come back down later in 2021, rather than runaway inflation. We do not believe that consumers will continue to spend so aggressively once the savings rate retreats. Rising input costs and inventory shortages will contribute to a short-term spike in prices, before reverting to more normal levels as supply chains also find some normality. At this stage, Central Banks are happy to sit on their hands, rather than react to short-term price spikes and hike interest rates. That could all of course change if we see a sustained period of inflated prices, and Central Banks have to intervene, but with global demographics being deflationary (older population = more saving and less spending), this seems unlikely. There is an important lesson for politicians too. What is most important now for the universal good is continuing to deal with the pandemic, supporting the recession and aligning business and macro strategy with the needs of the carbon transition for a cleaner world. None of this leads to a conclusion that the happy marriage between monetary and fiscal policy is about to be dissolved. Big central bank and government balance sheets are here to stay for some time to come. Hopefully sensible decisions will be made all round.

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