The consumer price index has risen to 2.1%, a level not seen since late 2018, fuelling fears that inflation is back. Are trustees expecting inflation to take hold? 

 

Inflation is perhaps a trustee’s worst enemy, and there are signs that after years of low inflation, the environment could be changing.  

 

In the UK, CPI as well as the consumer prices index including owner occupiers’ housing costs each rose to 2.1% in the 12 months to May 2021, above the Bank of England’s 2% target. Fears that prices will rise further were heightened by events in the US where CPI rose to 5% in the year to May, reaching its highest point since August 2008. 

 

 

Despite the uncertain outlook, pension professionals are trying to keep a cool head – all the while maintaining a sharp focus on price developments.  

 

“I’m in the ‘reasonably optimistic’ camp around this,” said Jeff Houston, head of pensions of the Local Government Association, speaking at the G7 Pensions Forum last week. 

 

Houston pointed to a recent report by the Bank of England’s Monetary Policy Committee that sees inflation going up above its 2% target in the short term but coming back to target in the medium term. This, he said, is in line with what the US Federal Reserve is saying, as well as with a Fed survey of professional forecasters. 

 

Even a small increase in inflation would be bad news for the Local Government Pension Scheme, which pays 1.7m pensioners around £9bn each year and revalues pensions of active members in line with inflation. “A 1% inflation increase would lock in about £2bn of long-term liabilities for us," noted Houston. 

 

Despite his optimism Houston tempered his positive outlook somewhat, warning against complacency and highlighting the many unknowns the economy is facing. He said unprecedented levels of peacetime government debt could tempt governments to inflate their way out of it.  

 

“There is a possibility that we might see inflation potentially being encouraged up,” he speculated, but how likely it is that this will happen is not clear given the current low cost of servicing debt. 

 

Another driver of inflation could be that global trade is under pressure through Covid; there has also been an increase in protectionist tendencies, with “reductions in supply side efficiency right around the world”, he noted, including the availability of labour. “It’s partly Covid, partly the B-word. But also that reverse from globalisation,” said Houston. 

 

In the short term, inflation might be driven by those who kept their jobs during the pandemic and were prevented from usual discretionary spending by lockdowns –building up household cash piles ready to be deployed. “12.5% of GDP is sitting in people’s bank accounts,” he noted. “So what do we do with it? Spend it on cars, holidays or save it? Is it going to be investment or another inflationary pressure?” 

 

 

The view on inflation is similar in other European countries, it appears. Torbjörn Hamnmark, head of strategic asset allocation at Swedish state pension fund AP3 also said he was “not super afraid of inflation at the moment”, arguing that the 5% inflation seen in the US was pandemic-related, but he also warned there are many other issues that could push up inflation, which could emanate from the “new era of monetary and fiscal policy in the US”.  

 

Climate change mitigation could be another big driver, said Hamnmark. The change to a greener economy “might increase investment and put costs on procedures that previously have been very cheap”, having been produced far away and shipped. “Those low inflation pressures from globalisation might change. This is in itself not a bad weather forecast but it will change the rules of the game on how you invest and how you make financial returns,” he predicted. 

 

Investors themselves could be creating some of the inflationary pressure, he observed, by excluding investments in oil and gas, speculating that a lack of investment could lead to short-term shortages as the economy transitions. 

 

Longer term he said consumer and credit flows “will probably be steered away from consumption to investment”, believing that global economic growth has been above potential for decades: “If you look at the past decade, it was basically central banks maximising growth to get inflation up. They started to succeed in that but it also meant we consumed a bit more than we had to.” 

 

AP3 currently holds 21% of its assets in private markets, with 3.7% in infrastructure, but Hamnmark said the fund was “pretty cautious at the moment” about making new investments – it is even considering adding cash to its strategic benchmark for the first time.  

 

Current bond yields mean cash is a comparable option, he explained, but there is also price pressure on private markets, which are “very expensive at the moment, so why not stay on the side for a while”.