Pete Comley, the author of the book Inflation Matters, has written a new paper outlining how the coronavirus crash could lead to a wave of inflation in the latter part of the decade.
He has written a special column for This is Money, explaining why.
Inflation may sink due to the immediate after effects of the coronavirus lockdowns but will then spike in the latter part of the decade before crashing in the 2030s, says Pete Comley
The Covid-19 pandemic is going to influence inflation and in quite a complex way, according to a recently published White Paper by Inflation Matters.
In the short-term, governments are shouldering the major cost of Covid-19, but in the longer-term, this burden may well shift to ordinary people if inflation takes off.
The Bank of England is predicting that inflation will decline to near zero in the coming year due to decreasing demand for many goods and services and the effects of declining commodity prices.
However, as the world recovers once a Covid-19 vaccine has been found, inflation may well push above the 2 per cent target and it could remain in the 3-5 per cent range for the rest of the decade.
This is because of the vast amounts of money being created by the UK and other governments.
Over the long run, there has been an almost one-for-one link between money supply (less GDP growth) and inflation.
However, from the 1990s growth in money supply has outpaced inflation.
Much of that excess money supply has been locked up in assets eg shares and housing. The extra money created in the 2009 Quantitative Easing mainly repaired bank balance sheets and did not reach the man in the street and so did not affect consumer prices much.
In contrast, the new money today is being injected directly into the real economy and will be inflationary.
The money supply has run ahead of the inflation index since the 1990s, says Comley
The UK government is likely to allow inflation to rise and will use it as a form of ‘inflation tax’.
There is a precedent for this. Historically, governments have not paid back borrowing created in national emergencies. Instead they have used inflation to reduce the value of a country’s debts in real terms and to make interest repayments more affordable.
They are also likely to hold base rates near zero for a long time to reduce their interest payments.
This scenario would have a number of implications for private investors. Specifically, ‘inflation tax’ would target bonds, resulting in negligible returns and a loss versus inflation.
Index-linked bonds appear to be no solution as they are currently overpriced and face a re-rating risk should the government switch their linking from RPI to CPIH, as is currently being discussed.
Furthermore, all bonds have an additional risk of capital loss when interest rates do finally rise.
The purchasing power of cash savings would also be eroded by potential ‘inflation tax’. For example, if we had six years of 5 per cent inflation and near zero interest rates, cash savings would reduce their real value by a quarter.
Investing more in shares in this situation looks like it might be a better option.
Historically, shares have returned a theoretical (excluding costs) 5 per cent per annum above inflation, a figure in line with the findings of the Barclays Equity Gilt Study and Credit Suisse Yearbook.
However, such levels seem doubtful in the coming decade. In the short-term, returns may be lower due to companies needing to repair balance sheets and invest in redesigning their businesses for a post Covid-19 world. This would result in lower dividends.
Longer-term, should inflation reach 4 to 5 per cent, real returns from shares could be halved. That said, they should at least preserve purchasing power over the long run.
If we do see higher rates of inflation, precious metals like gold have historically outperformed – particularly if inflation rates get above 4 to 5 per cent and towards 10 per cent.
Standards of living may be gradually eroded over the coming decade.
Wages rarely keep up with rising inflation. Even if they do this time, they will probably be linked to CPI, which typically lags 1 per cent behind RPI, which some feel more accurately reflects real cost-of-living.
State pension increases will suffer from the same problem, whilst many private pensions have capped increases to just 2.5 per cent.
At the same time, anyone saving into a pension, may also get hit by the ‘inflation tax’ on the bond element of their portfolio.
Looked at over the much longer term, Comley says long-lasting inflationary cycles followed by deflationary periods can be identified all the way back to the 1200s.
There is also a longer-term change in the inflation we may experience due in part to Covid-19.
Over time, history shows that inflation follows a wave-like pattern – rising for periods of up to 140 years and then prices remains at almost the same level for often a century. The overall cycle seems driven by global supply and demand and population growth.
In this context, it makes sense that inflation might reduce longer-term. China’s total population will start to decline in a few years and declining birth rates in developed countries mean that overall global demand is about to start falling.
The transition between the two periods has historically seen an inflation spike followed by a price crash. Previous end of cycles were caused by: famine and floods (1317); revolution (1650); and war (1813).
In the current context, it is not difficult to imagine a situation that might cause a spike/crash to happen.
Government money printing could get out of hand – it is going to be hard to stop the state largesse that Covid-19 has started.
Interest rates might then be raised to calm the rising inflation. This could lead to defaults across the whole debt market (consumer and corporate). The price of bonds would plummet.
Managing finances in such a transitionary period, if it were to occur, would be difficult as it could affect virtually all assets simultaneously – including cash.
The latest inflation wave has just 16 years to go before it reaches its end-of-cycle maximum of 140 years.
The White Paper Inflation Tax: The Implications of the Covid-19 Debts for Personal Finance can be downloaded for free at: inflationmatters.com/Covid19inflation/
THIS IS MONEY PODCAST
- How many state pensions have been underpaid? With Steve Webb
- Santander’s 123 chop and how do we pay for the crash?
- Is the Fomo rally the read deal, or will shares dive again?
- Is investing instead of saving worth the risk?
- How bad will recession be – and what will recovery look like?
- Staying social and bright ideas on the ‘good news episode’
- Is furloughing workers the best way to save jobs?
- Will the coronavirus lockdown sink house prices?
- Will helicopter money be the antidote to the coronavirus crisis?
- The Budget, the base rate cut and the stock market crash
- Does Nationwide’s savings lottery show there’s life in the cash Isa?
- Bull markets don’t die of old age, but do they die of coronavirus?
- How do you make comedy pay the bills? Shappi Khorsandi on Making the…
- As NS&I and Marcus cut rates, what’s the point of saving?
- Will the new Chancellor give pension tax relief the chop?
- Are you ready for an electric car? And how to buy at 40% off
- How to fund a life of adventure: Alastair Humphreys
- What does Brexit mean for your finances and rights?
- Are tax returns too taxing – and should you do one?
- Has Santander killed off current accounts with benefits?
- Making the Money Work: Olympic boxer Anthony Ogogo
- Does the watchdog have a plan to finally help savers?
- Making the Money Work: Solo Atlantic rower Kiko Matthews
- The biggest stories of 2019: From Woodford to the wealth gap
- Does the Boris bounce have legs?
- Are the rich really getting richer and poor poorer?
- It could be you! What would you spend a lottery win on?
- Who will win the election battle for the future of our finances?
- How does Labour plan to raise taxes and spend?
- Would you buy an electric car yet – and which are best?
- How much should you try to burglar-proof your home?
- Does loyalty pay? Nationwide, Tesco and where we are loyal
- Will investors benefit from Woodford being axed and what next?
- Does buying a property at auction really get you a good deal?
- Crunch time for Brexit, but should you protect or try to profit?
- How much do you need to save into a pension?
- Is a tough property market the best time to buy a home?
- Should investors and buy-to-letters pay more tax on profits?
- Savings rate cuts, buy-to-let vs right to buy and a bit of Brexit
- Do those born in the 80s really face a state pension age of 75?
- Can consumer power help the planet? Look after your back yard
- Is there a recession looming and what next for interest rates?
- Tricks ruthless scammers use to steal your pension revealed
- Is IR35 a tax trap for the self-employed or making people play fair?
- What Boris as Prime Minister means for your money
- Who’s afraid of a no-deal Brexit? The potential impact
- Is it time to cut inheritance tax or hike it?
- What can investors learn from the Woodford fiasco?
- Would you sign up to an estate agent offering to sell your home for…
- Will there be a mis-selling scandal over final salary pension advice?
- Upsize, downsize: Is swapping your home a good idea?
- What went wrong for Neil Woodford and his fund?
- The incorrect forecasts leaving state pensions in a muddle
- Does the mortgage price war spell trouble in the future?
- Would being richer make you happy? Inequality in the UK
- Would you build your own home? The plan to make it easier
- Would you pay more tax to make sure you get care in old age?
- Is it possible to help the planet, save cash and make money?
- As TSB commits to refund all fraud, will others follow?
- How London Capital & Finance blew up and hit savers
- Are you one of the millions in line for a pay rise?
- How to sort your Isa or pension before it’s too late
- What will power our homes in the future if not gas?
- Can Britain afford to pay MORE tax?
- Why the cash Isa is finally bouncing back
- What would YOU do if you won the Premium Bonds?
- Would you challenge a will? Inheritance disputes are on the rise
- Are we primed for a Brexit bounce – or a slowdown?
- How to start investing or become a smarter investor
- Everything you need to know about saving
Some links in this article may be affiliate links. If you click on them we may earn a small commission. That helps us fund This Is Money, and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.