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POLICY RESPONSES TO INFLATION
These rate rises will be needed to tackle inflation, which
reached 6.8% in the US and 5.4% in the UK in November. The
European Central Bank insists rate rises won’t be necessary in
2022 in the eurozone, however, although inflation did hit 4.9%
in November.
Sharply rising inflation after many years of flatlining means that
policymakers will have some tough choices to make in 2022.
The global economic recovery from the pandemic is still fragile
and could be jeopardised if rates are raised too fast. But if
inflation spirals out of control then a failure to raise interest rates
to stifle it could also be a costly policy error.
Inflation can harm equities by creating business uncertainty and
raising the costs of inputs. Those companies that have sufficient
market power will be able to pass on these extra costs to their
customers, however.
Inflation also harms bonds because the interest they pay, known
as ‘coupons’, are usually fixed nominal values so rising inflation
undermines the real value of these.
INVESTING FOR THE LONG TERM
The professionals who trade and invest use interest rate
and inflation expectations, as well as many financial
and
other
economic
indicators, to anticipate the
future direction of financial
markets and trade for the
short term. For investors,
however, the goal should
be to allocate to assets that
will deliver value over the
longer term.
Knee-jerk asset allocation
rarely yields positive results.
Rather than attempt to time
markets, it is better to allocate
for the long term and tilt welldiversified portfolios in response to changes in
fundamental factors, preparing for future market
realities rather than over-reacting to them.
Central banks are moving towards tightening policy – and
there are understandable worries about how this might affect
economic recovery – but they are acting in a very marketfriendly way and higher borrowing costs are already factored
into asset prices.
The conditions are in place for a sustained boom in real
growth with excess savings boosting consumption and an
accompanying tailwind from falling unemployment. As such,
it is possible to remain positive on risk assets and take a
balanced, flexible approach where investors can focus on longterm themes and build diversified portfolios designed to perform
throughout the cycle.
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