Published: 26th July 2023 (1 Min Read)

While the inflation narrative in the rest of the developed world is finally aligning with central bankers’ expectations and continuing to fall steadily, here in the UK it is proving a lot stickier.

Wage pressure, particularly in a public sector held back since 2010 by the government’s austerity policies, has been effective in achieving hikes not far off inflation levels. With unemployment remaining tight, and consumer confidence surprisingly strong, inflation has remained high. We do not believe that the UK is already in a wage price spiral akin to the 1970s, but just drawing on exogenous factors like pent up global Covid demand and the war in Ukraine to explain the inflation only tells part of the story.

Can we see light at the end of the tunnel? Wholesale energy prices have fallen a lot and although this may not yet have fed through fully to consumers, it should do before the end of this year.

Supermarkets have also started to report falls in food prices. These are two main sources of externally generated inflation and so falls should help to bring down inflation significantly in the second half of this year.

The Bank’s policy since the end of 2021 of raising interest rates to slow down the economy takes 18 to 24 months to take effect. Because rates began to rise about 18 months ago, we should expect to see the economy slowing down soon and with it, the rate of inflation. The June 2023 CPI print, at 7.9%, was lower than expected which has been taken positively by the market.

The Capital Preservation strategy continues to have a difficult time in this rising rate environment, given its core exposure to bonds which typically do badly when interest rates go up. UK Gilts in particular have been hit hard, so we added a short-dated low coupon UK gilt in June. At a price of around 92p, we are guaranteed a return of approximately 8% in January 2025 when the bond matures at 100p (plus 0.25%pa interest up to then) on UK government risk which we think will prove attractive, subject to the UK not defaulting. To fund this, we sold the M&G Global Macro Bond Fund.

The allocation within the strategy to alternatives has also been troubled by rising rates, as investors demand a lower share price to compensate for the higher discount rate that should be applied, given the rise in risk-free rates, to the long-dated cash flows of, for example, infrastructure companies. Alternative investments tend to be in closed-ended vehicles like investment trusts and companies and so their discounts to NAV blew out in the second quarter of 2023 as share prices fell while NAVs barely changed. We believe these movements are temporary and will revert in due course.


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Article written by
John MacMahon