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Central banks tested by less growth and more inflation

As the world begins its recovery from the pandemic, the themes of growth and inflation have been common watchwords. And in the last quarter global markets have delivered less growth and more inflation than had been expected. Julian Broom, our Chief Investment Officer, explores the latest investment developments.

With ongoing lockdowns in many countries and issues with shipping and supply lines continuing, growth forecasts in the last few months have drifted lower than earlier predictions.

The inflation rate increases were originally put down to ‘one-offs’, but as these endure it’s worth considering whether these anomalies are fast becoming the status quo. As a result, workers will be more inclined to demand higher wages as compensation for the loss of real income. The more of this we see, the greater the chance the market will price a more substantial inflation risk.

Supply chains too have created real issues; Covid restrictions initially stretched matters, but investors took little notice, assuming that things would soon return to normal. Something of a reality check is definitely needed though. The shipping situation is not really easing (especially with ongoing restrictions across Asia) and other factors including energy supply issues, labour shortages and the increased costs of transporting goods internationally are in play too. As a result, it’s clear that a much more volatile situation for world markets could easily arise.

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With all this in mind it seems likely that these challenges will be with us for the rest of the year at least, if not well into 2022 and perhaps beyond.

From an investment perspective, the ‘buy on the dip’ mindset holds in equity markets. This is partly because, despite the inflation concerns, we still have supportive policies from the central banks, but is also down to the momentum trade ie the belief in markets that, ‘what has been going up, will keep going up’. Growth generally is now dependent on the need to unplug supply bottlenecks quickly. If that happens, we could see a strong end to the year from the markets, if not, the final quarter of the year may be quite a test for central banks, especially the US Fed and the Bank of England who both face possible further increases in inflation.

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