Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

There are a couple of conclusions we might draw from the latest UK inflation data. At 0.6% in December, the annual rate of inflation is, unsurprisingly, staying low during the pandemic1. With fewer opportunities for consumers to spend and fewer reasons for doing so under lockdown conditions, the upward pressure on prices remains relatively weak.

At the same time, consumer prices rose at double November’s 0.3% annual rate. Higher prices for some items – including clothes – following extended Black Friday sales in November may have accounted for part of the rise, alongside seasonal increases in transport costs. January’s data will now be closely eyed to see if these price rises represent the start of a developing trend or merely reflect short term changes to pricing that will soon be reversed.

At the start of 2021 it’s apt that inflation is back on the agenda. Ever since the financial crisis of 2008, inflation has consistently undershot forecasts across most of the world’s major economies, despite sustained economic recoveries. The reasons for this are still not completely understood, especially given the vast efforts central banks and governments have brought to bear on boosting jobs and growth.

One theory is that the financial crisis indelibly damaged confidence to such an extent that workers became permanently more liable to accept lower wage settlements and lower paid work and consumers turned irreversibly more restrained and price aware. These pressures may have held inflation in check ever since.

If this is true, you might expect the pandemic to only have increased the downward pressure on inflation. Unemployment across OECD countries is estimated to have been about 7% at the end of last year, compared with 5.3% at the end of 20192. Moreover, furlough schemes may have deferred some job losses, meaning that unemployment is likely to remain elevated well into this year and beyond.

In the UK, the savings ratio – a measure of how much people save as a proportion of their disposable income – rocketed to a record high of 27% in the second quarter of last year, and remained well above the levels seen in the aftermath of the 2008 financial crisis a quarter later3.

This unprecedented rise in the savings ratio could be interpreted in two ways. It may reflect record levels of concern about the outlook for jobs, among both the recently unemployed and others holding relatively insecure positions. It may also indicate the unique nature of the current crisis – that it has physically prevented consumers from making some purchases and nullified the need to make others.

Quite what the balance between reticent and frustrated consumers actually is we shall only know once social restrictions have been lifted and consumers are, once again, free to express their true spending intentions.

What is clearer though is that governments have massively raised their spending ambitions. Heightened spending on healthcare, job support schemes then infrastructure stands to prime economic activity in the real world in a way that quantitative easing – the process whereby central banks print new money to buy assets like bonds – cannot.

The UK government has laid out plans to invest £600 billion in infrastructure over the next five years, in an effort to upgrade roads, rail and broadband cables, “level up” the regions, create large numbers of new jobs and work towards achieving net zero greenhouse gas emissions by 20504.

Importantly, the UK doesn’t stand alone. The inauguration of Joe Biden as US president could signal the start of a new age of federal spending, given the president’s stated aim of building a modern, sustainable infrastructure for America and transitioning to a greener economy.

With the Democrats holding only the slimmest of majorities in the Senate, an early, big infrastructure bill has its attractions, not least because it might have a better chance of winning bipartisan support than some of Biden’s other, more radical plans.

At the same time, China, the main source of excess demand for commodities in the 2010s, is leading the global race back to growth. China’s economy grew by 2.3% last year, owing largely to the country’s decisive handling of the pandemic. Exports and investments in China’s infrastructure and real estate development made substantial contributions to the nation’s growth, a pattern that could continue into 20215.

Of course, major moves like these entail inflationary risks. Industrial commodities have already gained considerable ground since the middle of last year, in expectation of an infrastructure-led recovery, and they could cover much more ground yet.

This comes at a time when the brakes on inflation are, in an important sense, partly off. Central banks charged with keeping inflation in check have, in some cases, also increasingly turned their sights on achieving maximum or near-maximum employment.

Most notably, the US Federal Reserve relaxed its 2% inflation target last year in favour of something much less rigorous – "inflation that averages 2% over time"6. Given that inflation has been below 2% for some while, this implies the Fed won’t be as quick to fend off a rise in inflationary pressures with higher interest rates.

Assets that at least keep pace with inflation over time ought to be a minimum requirement for investors. With inflation so low in the recent past, this aspect to investing might easily have been overlooked, but it may not remain that way for a lot longer.

The increasing likelihood that we are about to experience higher rates of inflation than for some time, suggests it makes sense to look to some less familiar sources of investment returns. Fidelity’s Select 50 list of favourite funds offers a number of ideas for a world in which government-led infrastructure spending plays a greater role and improving world growth sets inflation on a higher path.

The FP Foresight UK Infrastructure Income Fund is focused on UK investment companies that own renewable energy and other infrastructure assets. As such, it can be expected to offer some protection from rising inflation, since infrastructure assets tend to be exposed to inflation-linked contracts and regulations. The portfolio is diversified across a range of renewable technologies, including wind power and solar photovoltaics, and aims to achieve a 5% annual income from its investments, though this is not guaranteed.

Gold remains a potentially attractive investment in an environment where inflation erodes the buying power of paper currencies. Fidelity has one gold fund on its Select 50 list – the Ninety One Global Gold Fund. Better known, perhaps, under its previous name, Investec Global Gold, this fund invests in a diverse portfolio of gold mining companies worldwide. It also has the flexibility to buy physical gold ETFs and shares in companies that mine for other precious metals, and currently has a 4% exposure to silver7.

Source:

1,3 ONS, 20.01.21 and 22.12.20
2 OECD (2021), Unemployment rate forecast (indicator). Accessed on 21 January 2021
4 GOV.UK, 25.11.20
5 National Bureau of Statistics of China, 18.01.21
6 Federal Reserve Bank, 27.08.20
7 Ninety One, 31.12.20

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics covered:

ChinaGlobal; Interest rates; North AmericaUKVolatility

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