Government spending levels also remain very high in the UK and in most major economies. More government spending is needed to meet carbon emissions targets.
Temporary shortages are lasting longer than expected for two essential inputs to traded industrial and consumer goods: container shipping and semiconductors. Both are putting upward pressure on costs and prices.
High inflation
All of this has propelled inflation to the upper end of the range for the past quarter century, of 1 to 3 per cent a year. Even so, we are still some way off the levels of inflation that have troubled investors in the past.
Our own long-term studies showed that when UK inflation averaged 4 to 6 per cent a year, multi-asset portfolios suffered, as equity returns failed to keep up with inflation.
The transitions to these high-inflation eras coincided with more than just powerful economic recoveries. There were either wars or revolutions that smashed trade and created scarcity, or fundamental shifts in government policy away from keeping inflation low and stable.
Eventually consumers and businesses upped their expectations of future inflation and set in motion self-reinforcing cycles.
High-inflation outbreaks are uncommon and your chances of correctly forecasting such big structural shifts are not high. What makes it challenging is the complexity of our highly integrated, multipolar global economy and the slow-moving nature of structural changes.
There is scant evidence of forecasters getting these big calls right and far more evidence of them getting it wrong.
So, instead of basing your investment strategy on an inflation view, you can use two strategies to tilt the odds in your favour. The first is to bias portfolios to better value opportunities that have a bigger margin of safety priced in.
These investments are more likely to provide higher returns and offset any higher inflation. Our research flags energy equities, UK equities and emerging market bonds as attractive, and these feature in our Morningstar managed portfolios and multi-asset funds.
The second is to test portfolios for a wide range of different economic and market scenarios, not just high inflation. This can reveal which scenarios are best and worst for performance as well as less obvious sources of diversification.
From this type of analysis, we can still see a role for high-quality government bonds in specific deflationary shocks. Foreign currency is also effective as a diversifier against UK-specific inflation risks such as Brexit-related impacts on labour costs and imported goods prices.
While inflation pressures are building, the hallmarks of a high-inflation environment are not present today.
Instead of trying to guess what inflation will do next, investors are better served by building portfolios of the most attractively valued investments they can find and the least expensive diversifiers.
