Around 26 months ago, inflation flickered back to life in the West, and what a whirlwind it has been since then. Market shocks, rising yields and an increasing risk-free rate changed how some invest. But has this led to ultimately poor decisions, with more consequences to come?
Looking back, rising prices were initially not even considered a risk: inflation was long-eradicated. And so the upward spiral of prices caught central banks off guard, some more so than others. The consumer price index in Britain began to rise midway through 2021, having started the year at a tiny 0.6 per cent, and it carried on climbing until it topped 11 per cent in October last year. Since then, it has dropped to 6.7 per cent, and by the end of the first quarter of next year, the Bank of England (BoE) expects it will have eased to 3.4 per cent.
However, that is still higher than the BoE's target, and even then it's unlikely we will be out of danger considering the potential shocks posed by escalating geopolitical tensions, the disruption of globalisation, climate change and soaring rates of national debt. The World Bank warned this week that if the conflict in the Middle East intensified, global oil supply could shrink, sending prices per barrel to between $140 and $157, with repercussions for prices across the board.
The BoE is keen to reinforce the message that rate cuts next year are unlikely. It confirmed this week that bank rate is being held at 5.25 per cent – with three members of the Monetary Policy Committee (MPC) voting to raise it to 5.5 per cent. Pantheon Macro however is sticking with its forecast that the MPC will reduce bank rate by 75 basis points (bp) next year, with the first 25bp cut coming in May. It reckons that the bank's stance will shift as the economic data changes.
Kallum Pickering at Berenberg makes the point that probably less than half of the BoE’s tightening since October 2021 has actually passed into the real economy so far. Britain thus faces many more months of “de facto policy tightening" even after policymakers have stopped raising rates. So there is little chance the pull on the economy, households and businesses will wane just yet.
It’s been a bruising experience thus far. Share and bond prices have come under pressure, with yields on the latter surging along with interest rates offered on savings accounts. But if decent returns on risk-free assets felt like a silver lining, it might not have been after all.
The price cash savers have paid has been to sacrifice around twice as much value to inflation as they have earned in interest, according to Janus Henderson Investment Trusts’ annual cost of cash survey. Since January this year, despite record interest income of £32bn, inflation has eroded the value of cash sitting in accounts by £69bn.
By contrast, investors in global equities over the same period enjoyed returns six times larger based on the MSCI World returns between January and late September. Even the UK index returned more than cash at 4.3 per cent. But if cash cannot compete with inflation, is the stock market – with its promise of capital gains, dividends and a record of outperforming cash four-to-one over the past 25 years – healthy enough to entice risk-averse savers?
Two Q3 reports, from AJ Bell and Computershare, hint at pressure building on dividend payouts but also at their enduring strength. AJ Bell, whose report aggregates City forecasts for FTSE 100 companies, says that while pre-tax profits across the FTSE 100 are expected to rise by 10 per cent in 2023, that’s down on the estimate of 19 per cent from three months ago. The total FTSE 100 payout is expected to be close to £79bn, giving a yield of 3.9 per cent for 2023, as it warned that dividend cover is expected to fall thanks to an anticipated drop in underlying net income.
According to Computershare’s latest Dividend Monitor, UK dividends fell 8.3 per cent in Q3. This was due to payouts from miners falling by a quarter, with special dividends also down – partly on lower M&A activity as higher interest rates made financing more difficult. Utilities made the biggest positive contribution thanks to their inflation-linked dividend policies, and the bank and oil sectors were also major contributors. Computershare forecasts a yield of 4 per cent on UK equities over the next 12 months, but it too warns of some uncertainty as the drivers of corporate profitability are impacted by the rising cost of finance.
So what will risk-averse investors do? Based on the outlook for UK income (Bearbull discusses this in more detail here) it would be easy to stay risk-off. However, as Investors' Chronicle has highlighted before, while the impact of rising rates is yet to fully impact the economy, its effect on savings rates has started to show weakness. Elevated inflation remains a risk and will bring higher-for-longer interest rates but now the talk is of when cuts might begin. National Savings & Investments has led the way in closing 'best buy' accounts, and others will follow. The negative impact on dividends is potentially approaching its nadir, but the positive impact of higher rates on cash has most certainly reached its peak.
