Inflation has been on the rise recently in the UK and around the world. Is this rise transitory, as central bankers are saying it is, or persistent and therefore cause for concern? The importance of this question cannot be understated. The high inflation of the ’60s and ’70s did huge damage to economies and financial markets – as did, for a while, the high interest rates in the early ’80s that were needed to stamp it out. Balanced funds – those investing in bonds and equities in similar proportions – performed far worse in real terms during what is known as ‘The Great Inflation’ than they did during the two financial meltdowns of the 1930s. The reason for this was that although the deflation of the ’30s was bad for equities, it was great for real returns from government bonds. The Great Inflation on the other hand hit both. The stated aim for central banks, explicitly or otherwise, is to maintain stable prices and achieve full employment. However, these are not mutually exclusive. There may be circumstances in which a level of employment that is deemed below full can cause inflation to rise. Take the present, for example – unemployment is still high but labour markets are tight – causing wage pressures to increase – because Covid-19-related enforced saving has led, at the margin, people to feel they do not need to work. The role of inflation expectations is critical.

Once there is a belief that above-target inflation is here to stay, non-transitory positive feedback loops, known in the trade as multiple expectations-based dynamic feedback loops, can drive it relentlessly higher. Furthermore, anchored inflation expectations rely on a widespread belief that central banks will do whatever it takes to stop inflation expectations rising too much. For the US Federal Reserve to say that it will tolerate above-target inflation for an unspecified amount of time but also that the recent high and rising inflation is transitory appears contradictory and risks damaging its most important asset: its credibility. The structural forces that are deemed by many economists to have driven down the natural rate of interest – and with it inflation – over the past 40 years such as ageing populations, high wealth inequality and how labour intensity still prevail. Once the current drivers of high inflation, namely base effects and artificially high savings rates are behind us, these forces may re-engage.

Past performance is not a reliable guide to the future. The value of investments and the income from them can go down as well as up. The value of tax reliefs depend upon individual circumstances and tax rules may change. The FCA does not regulate tax advice. This newsletter is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as of September 2021 and the contents of the Finance Bill. No action must be taken or refrained from based on its contents alone. Accordingly, no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.