Inflation: From a roar to a whimper?


20 Feb 2024

How will an end to rising prices affect UK bonds and just how reliable are the measures of inflation underpinning this market? Stephanie Hawthorne surveyed an eclectic mix of experts for their views.


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How will an end to rising prices affect UK bonds and just how reliable are the measures of inflation underpinning this market? Stephanie Hawthorne surveyed an eclectic mix of experts for their views.

The spectre of 1970s-style inflation, a distant memory now but long thought vanquished, is still haunting the markets in 2024. In September 2023, rocked by a series of shocks – Brexit, Covid and Ukraine – Britain’s consumer prices index (CPI) measured 10.1%, its highest rate for more than 40 years.

Since then, inflation has tended to fall, but is still well above the Bank of England’s 2% target. It expects steeper falls this year. Indeed, commodity prices have already fallen sharply from the spike seen in February 2022 when Russia invaded Ukraine.

Yet, after trending downwards, there was a surprise uptick in the latest UK inflation figures released on 17 January: CPI rose to 4% to December 2023 with food prices still eye-wateringly high at 8% and the cost of services sticky at 6.4%.

Further afield, eurozone inflation rose to 2.9% in December, up from 2.4% a month earlier while US inflation increased to 3.4%.

The rate of inflation matters to us all – from institutional investors to benefit claimants yet we see “through a glass darkly” with its path uncertain to 2024 and beyond. Indeed, portfolio institutional asked various experts for their predictions with inconclusive results.

One expert was Paul Rayner, head of alpha strategies at Royal London Asset Management, who seems to best sum up the uncertain outlook for 2024: “Labour markets remain tight, with European unemployment reaching its lowest level in 25 years and pay rises globally at worrying levels for central banks. “Meanwhile, geopolitical risks remain elevated; the attacks in the Red Sea and Panama Canal blockages are already putting upward pressure on goods prices meaning inflation could remain sticky.”

Rayner expects “global inflation to fall further in 2024, with US inflation falling to 2.7% and in the UK to 2.4% and remaining close to these levels in 2025. This, though, is still well above the target levels for the Federal Reserve and the Bank of England.”

Remarkably, the disinflation during the past year has come without much visible damage to the labour market.
Altaf Kassam, EMEA head of investment strategy and research at State Street, says that outcome reflects the unusually strong starting point for labour markets across most developed economies.

“What was a hope a year ago has turned into reality: central banks, in their rate-hiking anti-inflation fight, have managed to restrict increased job openings without eradicating any jobs,” Kassam adds. “That said, the ground becomes shakier from here. Job openings have indeed been declining and the ‘margin of safety” is rapidly thinning”.

“The time has now come for central banks to end the tightening cycle and allow prior hikes to filter through the economy,” he adds.

The hard inflation fight

In the UK, the inflation fight may be harder than in most other countries as there is an additional layer of uncertainty due to labour shortages in some sectors.

Felipe Villarroel, partner of portfolio management at Twenty Four Asset Management, says: “The number of people who claim they cannot work due to long-term sickness continues to be high and this puts pressure on wages. Since the pandemic started this number has increased from 2.1 million people to 2.6 million.”

Royal London’s Rayner believes that bond markets have already priced in close to six interest rate cuts in most major markets by the end of 2024. “The improving outlook for base rates led to over a 100bp fall in yields in the last quarter of 2023. With inflation remaining above target, this pricing of interest rate cuts may be ambitious.”

Gareth Colesmith, head of global rates and macro research at Insight Investment, concurs. “There is significant scope for disappointment if central banks fail to deliver, and rates are eased more slowly than markets expect despite a possible backdrop that is largely supportive to the bond market.”

The end of 2023 had priced in around 150bp of cuts for the US and UK. Colesmith is far from optimistic. “Barring a significant drop o in economic activity, markets have made this disappointment almost inevitable. A combination of lower long-term rates, higher equity markets and tighter spreads have led to a significant easing in financial conditions. In effect, markets have already unwound the 100bp of rate hikes undertaken by the Fed in 2023, reducing the need for the Fed to do any- thing at all. The picture is similar in the UK.”

Derry Pickford, asset allocation specialist at Aon, points to other factors that might drive bond yields lower. “The FOMC [Federal Open Market Committee] minutes, published on 3 January 2024, suggested that the FOMC is looking at curtailing quantitative tightening and that might spur the Bank of England – which has been even more aggressive than the Fed – to do something similar.”

Many questions remain. The playoff between financial conditions and central bank policy is likely to characterise the investment landscape for the year ahead. This does not sit well with Colesmith. “If yields correct upwards as markets price in a more realistic path for rates, financial conditions will become more restrictive and open a window for central bank easing. “If markets then rally, central banks are likely to, once again, become more reluctant to take rates lower. By taking advantage of these periodic corrections in yields, investors should be best placed to maximize their returns.”

Lloyd Harris, head of fixed income at Premier Milton Investors, favours short-dated stock “given the lack of duration exposure in this part of the curve and this is where I would be positioned on the curve, at this point in time, for 2024.”

By contrast, Iain Stealey, international CIO for fixed Income at JP Morgan Asset Management, suggests investors take a step back, as the long-term investment opportunity for bonds remains compelling.

“Barring a re-acceleration in inflation, we have seen the peak in rates and central banks are likely done with tightening policy. Their next move will be easing which historically has been a positive environment for fixed income,” he adds.

Secondly, he highlights from a valuation standpoint, core yields remain high relative to what has been available over the last couple of decades. “With inflation falling, this also makes them look attractive in real terms,” Stealey says.

As a result, he believes it makes sense for investors to consider locking in these yields before the central banks get going cutting policy rates and bonds yields move even lower.

Dodgy foundations

More fundamentally, are institutional investors predictions built on sand? Just how reliable are the official measures of inflation on which so much hope or doom and gloom depend?

An Office for National Statistics (ONS) spokesperson told portfolio institutional: “Our headline measures of inflation are designed to reflect the average change in prices of all goods and services as consumed by all households. We collect over 180,000 prices across over 700 different items to use in the calculation of our headline measures. We are con dent that these aggregate measures are an accurate reflection of overall inflation in the economy.”

In the UK, the ONS reviews its “shopping baskets” of items used in compiling the various measures of consumer price inflation annually. In 2023, 26 items were added to the basket and 16 were removed out of a total of 743 items. The influence of the pandemic on the basket, has faded from shopping habits in 2023.

The changes for 2023 point to the rise of new technology and an increasing awareness of the health and environment.

Additions included e-bikes, security or surveillance cameras, frozen berries and a new, detailed breakdown of rail fares based on transaction data, enabling analysis by ticket type. Removals included digital compact cameras, spirit-based drinks and non-chart CD albums bought in store.

Scrapping RPI and reverting to CPIH would revert to the eurozone’s methodology, making it easier for investors to make relative comparisons on more international norms.

Neil Mehta, RBC BlueBay Asset Management

In addition, the ONS is developing radical new plans to increase the number of price points dramatically each month from 180,000 to hundreds of millions, using prices sent directly from supermarket checkouts.

Yet Yona Chesner, senior investment consultant and head of investments in Manchester at Cartwright, says: “All measures of price inflation are necessarily subjective because they make a subjective choice of what to include in their ‘basket of goods’ that they use to calculate overall price changes.

“Individual consumers will feel inflation differently depending on where most of their costs lie. Methodology issues such as substitution mean that inflation can be understated even for someone whose cost base is broadly reflected by the ‘basket’.”


In the longer term, the Retail Price Index (RPI) is no longer a trusted measure of inflation and is being phased out.

In 2020 the government announced that from February 2030 the RPI calculation will be changed to use the data and methods of Consumer Prices Index including owner occupiers’ housing costs (CPIH). In effect, from that date, RPI will cease to exist as a separate index.

As RPI is the inflation index used to set many pensioners benefits, as well as the index used to calculate payments that the government makes to holders of its own inflation-linked debt, from 2030 individuals as well as investors’ wallets will be hit by the change.

The key difference between RPI and CPIH is that of methodology. In short, the way that CPIH is calculated means that it almost always comes out about 1% to 1.5% lower.

By way of an illustration, Cartwright points to historic annual RPI, CPI and CPIH from December 2023 to present.

Over that period, RPI has on average been 1.4% higher than CPIH with CPI being 0.1% higher than CPIH (although there was a brief period in August 2020 where RPI fell to the same level as CPIH – 0.5%)

Despite this statistical tsunami of a reform coming in 2030, bond markets do not price in any significant change in RPI inflation around that date. Indeed, when the change was announced, market reaction was barely noticeable.

Again, Cartwright sees this as a sign that gilt markets have been more driven by supply and demand forces – notably the demand from UK defined benefit pension funds – than the market forecasting a particular view on the timing of future inflation impacts.

Chesner sees opportunity here. “The astute bond investor may see this as an opportunity to benefit from the market’s lack of sensitivity to this future expected event.”

Indeed, RPI reform to CPIH in 2030 could have a large impact on assets linked to the former, such as index-linked gilts, DB pensions, student loans and mobile phone contracts.

Neil Mehta, portfolio manager at RBC BlueBay Asset Management, agrees with Cartwright’s analysis. “There are positive and negatives. Given RPI has averaged +1% higher than CPIH since 2010, this will likely mean lower future returns for holders of Index linked gilts and pension schemes, hence the pushback.

“Scrapping RPI and reverting to CPIH would revert to the eurozone’s methodology, making it easier for investors to make relative comparisons on more international norms.” But he warns: “The transition distorts the market forward inflation expectations-based measures, used by policymakers to anchor inflation expectations, such as ‘5yr breakeven’ as it will incorporate RPI and CPIH in its calculation.”

In conclusion

On the economic front, the path to that hoped for ‘soft landing’ may have a few detours.

Tessa Mann, director of macro strategy at Willis Towers Watson, sees attractiveness in nominal and real developed market government bonds in absolute terms and as a strategy for hedging against downside events. “Government bonds offer great value as we enter 2024, with yields still remaining high relative to the last 10 years.”

In general, fixed income is in a good spot globally with inflation falling and central banks starting to shift their tightening bias to a more neutral to easing bias.

This will ultimately bode well for bonds and fixed income. But RBC BlueBay’s Neil Mehta, says: “Be selective of jurisdiction and active when the asymmetry is favourable in a volatile environment for interest rates.”

Perhaps nimble footwork rather than passive investment is the watchword for 2024?


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