Don't fret over the inflation yo-yo

THE word "unprecedented" has been used to describe the pandemic so much that is has almost become cliched. But in debates on whether we are in for a bout of sustained 1970s-style inflation, it is worth remembering just how unprecedented the pandemic really was for the economy, as this provides clues on the prospects for inflation in the second half of the year.

Take cinemas, for example. Around the world, cinemas have been silent for a considerable amount of time, and over a year in some countries. This has had an unprecedented effect on cinema prices, as people were physically unable to go out and buy tickets.

And the same can be said for commodities. Oil prices nosedived between March and April 2020 but have since recovered, and we've seen surging prices across industrial goods, energy and agricultural goods.

This trend was repeated in other sectors around the world, with most economies experiencing disinflationary pressures under lockdowns.

It is therefore expected that once these unprecedented economic shutdowns ease, we will experience a bout of reopening inflation once the shutdown or disrupted industries spring back to life, and consumers get back out spending again.

What goes down must come back up, and so what we're seeing at the moment is simply an inflation yo-yo. Inflation is making up for lost time, as it were. We may even see prices increase beyond pre-pandemic levels given the ongoing supply constraints and physical capacity constraints due to social distancing measures.

As a result of these inflationary pressures, we've seen the market transition away from growth assets, particularly tech companies whose future earnings become less valuable in a high inflation environment, towards value-oriented assets.

IT'S ONLY TRANSITORY INFLATION

But the question on the minds of investors and central bankers alike is whether the current inflation is temporary, or whether it will be sustained over the medium to long term?

Rising prices shouldn't be too great a cause for concern, as this really is only transitory inflation. The driving factor behind recent increases in prices is the fact that inflation fell flat this time last year as the world shut down. Once the initial bout of reopening inflation has run its course, we should see it settle to some semblance of normality.

We haven't seen the velocity of money - the rate at which money changes hands - pick up to the level we might have expected. Consumers are, in fact, taking money out of the economy by building up savings and not taking on debt, rather than actively purchasing and bidding up prices.

All that said, what economists are looking out for is whether the reopening of the economy and supply shortages make their way into higher wages and higher inflation expectations among consumers, particularly if central banks continue with their loose monetary policy for too long. This is when inflation may stop being transitory, and become something much more concerning.

But for this to happen, it would require higher prices to feed into higher wages. Unlike in the 1970s when labour markets were highly unionised, this seems much less likely here and now. It would also require central banks and policy makers to maintain loose monetary policy for longer, but this can be avoided if they have a credible commitment to tame inflation.

While the prospect of sustained inflation remains unlikely, investors should play close attention to what is happening to price levels. The modest bout of inflation has already resulted in a rotation towards value assets, so it will be wise for investors to be pre-positioned for any inflation to come. This can be achieved through a diversified, multi-asset strategy that is ready for the value rotation. Don't fret over the inflation yo-yo, but it pays to be prepared.

• The writer is head of investments at AAM Advisory, part of Quilter.