Changing political priorities means inflation globally is likely to be higher in the years to come and could prompt central banks to abandon their 2 per cent target, according to Jonathan Gregory, head of fixed income at UBS Asset Management.
Gregory said the present direction of travel for UK inflation and the rest of the developed world is “downwards”.
However, he said higher government spending and extensive tax cuts in the years ahead would lead to inflation being persistently higher than the 2 per cent target, and to the sort of levels advisers had become used to.
Gregory was speaking just hours after the latest UK inflation figure came in at 4 per cent, which was higher than expected.
But he said: “The reality is the trajectory is firmly downwards. The latest data showed [inflation] a couple of basis points above expectation but last month was a couple of basis points below expectations.
"Monetary policy operates with a lag, which means the effect of last year’s rate rises has yet to be fully felt.”
Gregory’s reason for believing that inflation will be higher over the longer-term is that "people want higher public spending (which would be expected to be inflationary) and they want tax cuts.
"That political environment should lead to higher inflation, structurally for many years.”
He noted that in the US, GDP growth has been strong but government spending has increased markedly, something which does not typically happen.
At present, central banks are mandated in the US, Eurozone and UK to achieve inflation at or near 2 per cent.
Gregory’s view is that such could be the persistence of inflation over the long-term that it may force central banks targets to change.
This is either by targeting an inflation number which is higher than 2 per cent over the long term, or switching to a nominal GDP target.
Nominal GDP is the combined inflation number and GDP growth number, so if GDP growth is 2 per cent, and inflation is 2 per cent, then nominal GDP is 4 per cent.
Because Gregory feels inflation will continue to fall in 2024, he believes it will be a positive year for bonds, with returns of around 4 per cent for the index possible.
But because fixed income rallied strongly in the final quarter of 2023, much of the potential good news is already reflected in the price at which bonds currently trade, meaning returns are likely to be lower this year than last.
Adam Darling, fixed income portfolio manager at Jupiter, also believed the latest uptick in UK inflation is a blip rather than a sign of things to come in the short-term.
He said: “Today’s inflation miss highlights the decline in inflation towards the Bank’s target won’t be a straight line.
"However, the underlying economic fundamentals in terms of a cooling job market, weak money supply and soft business and consumer confidence suggest that UK inflation should continue to fall and that the Bank should start cutting rates this year.”
