Why inflation is set to make a comeback

It’s been a long, hot September, and global activity remains muted. The Fed has put tightening on Ice with the market now anticipating modest interest rate rises through next year, while the Bank of Japan is chucking the kitchen sink of extreme monetary policy at the problem of deflation. While markets struggled with a host of conflicting signals and global events, we were sitting sweltering in the office wondering about where the UK economy goes next following the Brexit vote.

One of the KEY issues we are pondering is the extraordinary volatility of UK inflation linked Government bonds – the so-called Linker Gilts market. It’s a key indicator of future inflation expectations.

Although there is a “feel good” factor after the world didn’t immediately end on the Brexit vote, and a discernible feeling that recovery might be around the corner, the latest numbers from the Bank of England show inflation remains stubbornly flat at 0.6%, far short of the Bank of England’s 2% inflation target. The last data was well shy of the modest 0.7% expectations economists had for the last set of inflation numbers.

Yet, August and September has seen the price of Linker bonds rising rapidly, hinting at swiftly rising inflation expectations. That’s the clear dislocation between the Bank’s monthly look-back snap-shot of the historical numbers, and what the market expects is going to happen in the future. Linkers tell us inflation will rise!

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