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.

We live in a time of great ironies. This week we learned how a government-led response to the deflationary coronavirus pandemic – the Eat Out to Help Out Scheme – was the largest contributor to inflation falling to an annualised 0.2% in August1.

Last month’s large drop in inflation is unusual in that it wasn’t created by a fall in consumer demand but by supply-side price cuts. By all accounts, the public responded well to the eating out scheme, which offered 50% off food up to a value of £10. A temporary VAT cut for the hospitality sector also helped to drive prices down.

Understandably, the Bank of England struck a cautious tone after deciding to leave its key interest rate unchanged at 0.1% on Thursday. It said it plans not to alter monetary policy until there has been significant progress in using up spare capacity in the economy and inflation rises to 2% sustainably2.

Caution characterised the statement made by the US Federal Reserve Bank the day before, in which it reiterated its resolve only to raise interest rates once full employment is achieved, even if inflation rises above 2%. The American central bank expects its preferred measure of core inflation to remain below this level until 20233.

In Britain at least, there are a number of reasons to believe the current bout of very low inflation won’t last. The restaurant subsidy scheme is now over and other, lesser factors behind last month’s inflation fall – lower air fares and smaller price rises for clothes than a year ago – are also likely to have been temporary effects linked to the coronavirus.

Meanwhile, low oil prices have been helping to keep a lid on inflation so far this year. At around only US$43 per barrel yet with demand from China picking up, that tailwind may have been largely used up.

Just as importantly, the responses of world governments and central banks to the pandemic have been focused on priming economies with record amounts of stimulus including cash payments and tax breaks. Potentially that means more money washing through the economy – provided the pandemic relents or a vaccine is found and confidence improves.

There are a couple of further big unknowns this year that could affect inflation. The first is how much unemployment increases this autumn after the government’s furloughing scheme unwinds on 31 October. The Bank of England believes the rate will rise to about 7.5% in the final quarter of this year, from around 4.1% now4. If anything like this figure is reached then we might expect to see a further drag on inflation, this time, demand led.

The second unknown is whether or not the Brexit transition period will end with a trade agreement between the UK and the EU. A “no deal” could cause the pound to weaken and mean new costs for businesses so far relatively unaffected by the pandemic. This could challenge the current economic recovery yet produce higher inflation at the same time.

The Bank of England’s latest forecast is for inflation to remain below 1% until early next year5. That’s still low and significantly below the Bank’s target rate of 2%. This implies scope for more monetary easing in the meantime, even if only as an extra insurance against the UK economy slipping back towards recession conditions. Further money printing (quantitative easing) or even the introduction of negative interest rates remain possibilities.

While uncertainties over the inflation outlook abound it makes sense not to become too allied to one investing style or another or to disregard government and corporate bonds as diversifiers and alternative sources of income.

Low inflation favours shares in growth companies with pricing power – so businesses with products and services consumers are reluctant to give up. The past strength of the global technology sector – dominated by US and Chinese tech and social media companies – is all the more understandable in the light of low inflation.

However, value companies could undergo a revival if inflation picks up. Banks and oil producers would likely be among those to benefit from a more normalised picture of moderate economic growth and inflation and, eventually, higher interest rates. Companies with high debt levels or, perhaps, retailers exposed to rising wholesale goods prices, would likely perform less well under these conditions.

Bonds should remain well supported in the current environment of low inflation and interest rates close to zero. The income they can provide is more attractive when cash yields are so low and the absence of significant inflationary pressures poses less of a risk to the value of their income payments to be made years ahead. A cut in UK interest rates to below zero – while less likely than a further round of money printing – could potentially drive government bond yields further down and prices up.

In such uncertain times, a multi-asset fund can provide investors with a smoother ride. The Fidelity Select 50 Balanced Fund is one such example. Investing principally in funds on Fidelity’s Select 50 list, this fund spreads risk via a broad exposure to equities, bonds and cash. The amounts committed to each type of asset are constantly monitored and varied to capitalise on where the best investment opportunities lie. The Fund is not only diversified by asset type, it invests globally too. The Fund’s largest exposures currently are to the US, the UK and the eurozone. Bonds account for approximately 33% of the portfolio, with 52% in equities.

More on the Fidelity Select 50 Balanced Fund

Source:

1 ONS, 16.09.20
2,4,5 Bank of England, 16.09.20
Federal Reserve Bank, 16.09.20

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. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. 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

Active investing; FundsInterest ratesNorth AmericaUK; Volatility

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