Jeanne Asseraf-Bitton, Lyxor's Head of Cross Asset Research
A notable revival in global growth last year prompted a rise in inflation expectations. The question now is whether inflation will climb too high too quickly.
Central banks are watching carefully but seem willing and likely, for now at least, to stay behind the curve: Deflation is harder to fight, than inflation.
They could face problems if inflation does pick up rapidly however. Most major governments are highly indebted and the personal incomes of an often unruly electorate would be squeezed.
For now, we expect interest rates to remain low everywhere except the US, where they will rise relatively gently to around 0.9% by year end.
Structural inflation drivers
- The peace dividend: Military spending has halved since 1988, but it has started ticking higher.
- Less will for budgetary discipline: The rise of populism has forced governments around the world to loosen their purse strings after years of budgetary constraint.
- Monetary unorthodoxy -Central bank balance sheets are far bigger than they were. This is unlikely to change, even with inflation rising, because economies remain fragile.
- A challenge to free trade - Free trade can be deflationary, but its importance in the developed world is waning. Protectionism could be on the rise.
- Sentiment change - The economic consequences of disinflation are increasingly unacceptable to the electorate.
Some deflationary forces are still evident however. Technology for example is likely to keep generating productivity gains and fostering competition, but it won't be enough to offset inflationary forces.
Regional outlook
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Eurozone: reflation later this year |
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Any real upward pressure on wages seems unlikely until next year at least. Currency moves are likely to be less influential. Growth is recovering, but it is not a major upturn. Bank lending is however on the mend, after significant growth in both 2015 and 2016. Loan growth does tend to be a good indicator of progress towards reflation, normally around nine months ahead. Businesses seem confident enough to raise prices for the first time in more than four years. We expect eurozone inflation to increase, driven by Germany, to around 1.5% by year end. |
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US: leading the way |
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The US economy is at full employment and wage growth is accelerating. CPI inflation stands at around 2.2%. Nevertheless, there are still some impediments to higher inflation. For example, the pace of rent increases could moderate. The strong dollar could also slow inflation's rise, but rise it will. We are forecasting a rate of 2.6% by end 2017, 0.3% ahead of consensus.
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UK: unique circumstances |
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Inflation is moving higher in the UK, largely on the back of sterling weakness ahead of Brexit. Forecasting models are unpredictable, so guidance from the Bank of England (BoE) may be a better indicator: It is suggesting inflation will accelerate this year and next. We don't expect sterling to depreciate much further, unless the BoE announces additional easing. For now they are likely to wait to see how Brexit unfolds. UK inflation should come in around 2.4% in 2017, which is marginally behind consensus.
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Elsewhere: EM pressures? |
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We see Japan crawling out of deflation this year, with inflation of 0.3%. The strongest pressure is likely to be felt in the emerging markets. Brazil's rate of 8.8% last year should drop to closer to 6%. China should see a mild uptick, from 2% to 2.3%. |
Oil price moves
Energy consumption is rising as growth picks up, but demand from China is waning. We expect a market driven by supply and believe US producers will eventually fill the gaps left by OPEC cuts. We see a median price of around $55 a barrel.
Why choose Lyxor to trade reflation?
With deflation the greater worry, investors could afford to be relaxed over the long-term impact of inflation on their portfolios. Now though, financial repression is receding and inflationary pressures are mounting. Investors need to ensure their portfolios are ready to exploit, or defend against, them.
From traditional products with charges as low as 0.07%, to groundbreaking solutions that provide exposure to inflation expectations, Lyxor ETF offers more tools to ride reflation than any other ETF provider. Read more at http://www.lyxoretf.co.uk/uk/en/instit/page/inflation
All data: Lyxor Cross Asset research & SG Research, January 2017. Opinions expressed are as at January 2017.
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