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Our views 22 September 2022

The Viewpoint: Inflation – the only way is up, for now

5 min read

Inflation has continued to surprise to the upside across developed markets. The consensus view implied by bond and equity markets is that the aggressive policies of central banks rising rates to slow the economy and reduce inflationary pressures will most likely cause a recession.

For example, rising rates will drive mortgage rates higher which in turn cools the property market and, with it, consumer sentiment and spending appetite. Higher rates on corporate loans and overdrafts cause companies to pay more in interest payments and encourage them to reduce any debt piles ahead of investing in growth projects. Whatever the mechanism, rising rates will slow demand and given the magnitude of rate rises and impacts of inflation already on consumers and companies, economists are finding it hard to see how a recession will not occur.

There are two problems to this set up currently. First, central banks and city economists may not have fully factored in the policies of governments who are working very hard to protect voters from the negative impacts of rising inflation. In the process, they are likely staving off recession and driving more long-term inflation. Second, despite it being some months since the start of rate rises and inflationary pressures, the companies we speak to are generally not yet seeing major slowdowns in customer activity. Granted, some have more recently highlighted a change in behaviour of consumers such as a North American retailer we spoke to last week, but this is more at the margin as many other management teams are indicating that demand remains strong and there is a lot of ‘pent up’ demand in their area of the economy. An example here might be a global industrial rental equipment company.

Despite this non-immediate transition of central bank activity to slowing the economy, it is challenging to see how a recession is avoidable given the apparent determination of central banks to reduce inflation. The supply of goods and services is hard to increase in the near term – oil fields, fertiliser, Russian gas, skilled labour – and so demand will have to fall to reduce inflation and central banks are determined to make sure this happens. Falling demand without a recession is going to be hard to achieve.

A final point though is our observation that despite all of this, many cyclical stocks in global equity markets appear to be pricing in a recession – so even if one were to occur, the relative downside in these stocks from this juncture might not be as bad as people fear. So, counter-intuitively as the recession unfolds it might be a good time to be buying cyclical stocks. Put another way, there is a difference between what happens in the economy and what you might want to do with your investments as it always depends on the price of what you are buying and selling.


For Professional Clients only, not suitable for Retail Clients. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.