Even as the Office for National Statistics (ONS) revealed inflation beat pundits’ predictions and hit 2.9% in May, dwindling economic activity suggested the chances of the central bank adjusting its position on rates looked slimmer than ever.
Commentators had expected inflation to hit 2.7% last month, but the actual figure surprised markets by touching its highest level since April 2014.
Industry consensus shows many believe inflation could hit 3% or more before the Bank of England (BoE) feels compelled to act and with only one Monetary Policy Committee (MPC) member, Kristin Forbes, in favour of a rate rise at the April meeting we may be in for a long wait.
No reason to raise rates
Ben Lord, manager of the M&G UK Inflation Linked Corporate Bond Fund, certainly saw no reason why the bank’s governor Mark Carney would increase rates from current historic lows.
"Many believe inflation could hit 3% or more before the BoE feels compelled to act"
He said: “With so little evidence of domestic inflation pressures, and with most inflation coming from ‘transient’ and exogenous forces, Mark Carney will look through CPI at 3%, 4% even 5% perhaps.
“In fact, if Brexit negotiations commence poorly, and if the government can’t get anything done without a workable majority and now with a viable and sizeable opposition, I would still argue that Carney’s last move at the helm may be in the looser direction.”
Viktor Nossek, director of research at WisdomTree in Europe, said the impact of a volatile sterling and a weakening UK economy meant the bank was unlikely to act soon.
“Combined with indications of economic activity weakening, as evidenced by both actual GDP and retail sales decelerating markedly against a backdrop of weakening business sentiment, the BoE is unlikely to tighten soon,” he said.
“It’s clearing the path for inflation to hit 3%”.
Uncertainty, while a much-overused word, does seem to be the root cause of inaction not just with investors but with central banks too.
Nobody knows what’s going to happen with Brexit or even with the make-up of the UK government after last week’s election, so the best choice for many seems to have been do nothing.
Is this the new normal?
Hargreaves Lansdown senior economist Ben Brettell said fund and portfolio managers may soon start revising their positions if inflation continued “apace” in order to adjust to the new state of play.
Nathan Sweeney, senior investment manager at Architas, has already begun to shift his allocation.
“Overall the UK stock market has seen a strong run since the referendum vote driven by a weaker pound and rebound in commodity stocks,” he said.
“Much of that is now factored into markets and after such a strong rally valuations look expensive, especially given the inflationary impact on consumer confidence.”
Sweeney added: “As such we are maintaining our underweight to UK equities and increasing exposure to defensive large caps at the expense of cyclicals and mid-cap stocks.”
Prepare now for an extended run of low rates and high inflation where diversification will be key but, ultimately, we will be for a long wait for rate rises.