Weekly review: will back to school mean back to inflation?

Macro Update 8 March 2021
March 2021
Steven Bell

Steven Bell

Managing Director, Portfolio Manager & Chief Economist, Multi Asset Solutions


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Risk Disclaimer

Past performance is not a guide to future performance. The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

Key takeaways
Will back to school mean back to inflation?

There’s a lot to talk about this week, so we won’t be covering the latest blow to the British royal family. As for financial markets, the return to school and progressive easing of lockdown restrictions are far more important for UK markets.

The inevitable result will be a rise in new coronavirus cases. This is already evident in parts of London, which also lag behind in the vaccination roll out.

Lockdowns to ease, but will this lead to inflation?

The key question is: will the vaccination programme prevent this feeding through to rising hospitalisations? My guess is that it will. If so, this means that lockdown easing can continue; indeed, there will be pressure on the government to move faster: pressure they will resist.

This doesn’t mean a return to normality, instead it will release a burst of pent-up demand for beauty treatments, staycations and going down the pub. Will this lead to inflation? It’ll certainly boost some prices. Anecdotal evidence suggests that the costs of weddings and holiday rentals have jumped but there probably won’t be a sustained move to higher inflation. But ‘probably’ is the word – economists (myself included) have done a poor job at forecasting inflation for decades. As recorded inflation picks up, fears of a sustained rise will surely increase.

A booming economy in the US

It’ll be a similar story in the US. Similar but not the same. People have been able to hug each other for a while and mobility in terms of airline travel is way higher than in the UK or indeed any other country. 16 states have already removed requirements to wear masks. The surge in pent-up demand is already underway, fuelled by the massive fiscal easing of the outgoing Trump administration. This boosted incomes by an astonishing 10% in January and no doubt contributed to the rise in the non-manufacturing Purchasing Managers’ Index to a boomy 58.8.

Fears of inflation and confidence in economic recovery also explain why the head of the US Federal Reserve did little to resist the rise in US bond yields last week. The Federal Reserve are now in purdah ahead of the meeting on 17 March.

Dismal progress in vaccine roll out for continental Europe

By contrast, lockdown restrictions are being extended in continental Europe due to their dismal vaccine roll out. After leading for so long in the race to beat the virus, Germany is faltering just as the finish line is in sight. But they might just be able to manage a final sprint. The finance minister said yesterday that they should be administering 10 million doses a week by the end of the month. That would be a dramatic turnaround.
UK Budget: spend now, pay later

I haven’t mentioned Rishi Sunak’s Budget. It was an impressive piece of work. Boost the budget deficit today and you get all the kudos form increased spending and low taxes. Raise it in the future, especially for business, and ordinary citizens cheer. One thing’s for sure: he won’t meet those tough public spending targets in the run up to the next election. The miserly 1% pay rise for NHS staff is already causing a torrent of negative press; this wasn’t mentioned in his speech. It might just be the equivalent to Gordon Brown’s £1-a-week increase in the state pension: a tiny increase that caused such an outcry that it has to be replaced with an even bigger increase than would have been considered acceptable in the first place.

Bond yields to rise; equities to outperform

So, I still predict that 10-year yields go to 2% in the US, 1.5% in the UK, and zero in Germany. But with all this economic growth, equities should still outperform. As I keep on saying, bull markets in equities are rarely ended by an upturn in the interest rate cycle; it is a downturn in the economy that does that. But the world economy, excluding China, is turning up.

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