Since the turn of the year, measures of inflation in Europe and elsewhere have turned higher.
Some of this can be explained by the rise in oil prices (circa 50%) over the past 12 months, but are we starting to see a more general move higher in inflation after years of ultra-low inflation and at times even deflation?
Eurozone annual inflation rate into and through the financial crisis, and up to the latest reading for January ’17
Has inflation really been low?
Contrary to official inflation readings, most people will say they have experienced high inflation in recent years – rents, childcare, education, insurance etc. However Central Banks focus on overall measures of consumer price inflation (for example the ‘Euro HICP’ measure above), and this is a big driver of where they set interest rates.
Interest rates in Europe, as set by the European Central Bank, have been sub-1% since 2012 and at 0% since 2016 – a highly unusual situation, and inconsistent with ECB policy if inflation is making a comeback.
Why does this matter to you?
One of the main drivers of mortgage rates is the interest rate policy set by the ECB. Indeed this is the sole factor that determines repayments on existing tracker mortgages. Higher ECB policy rates would mean higher mortgage repayments.
Low ECB rates have also had a big impact on driving down the cost of car loan financing, and many other types of consumer loans.
Bank deposit rates have never been lower. Higher official rates would likely mean some long awaited respite for savers, although the real return (after the effects of inflation) may be no better.
Official interest rates also have a big impact on pricing of other financial assets. It could be argued that years of artificially low rates post financial crisis have driven the value of certain financial assets beyond where they otherwise might be.
Are rates about to be raised in Europe?
In short no, at least not ECB official rates. However a rising inflationary environment, or at least confirmation that deflation is no longer a threat would likely mean the ECB does not need to ease monetary policy further. Growing inflation in Northern Europe, particularly Germany will lead to calls for higher rates but the ECB acts for the entire Eurozone, and much of Southern Europe remains in recession.
Although the ECB may not be close to raising official rates, the market could well start to adjust pricing of market interest rates and financial assets in anticipation of a higher inflationary environment. In fact it could be argued that this has started, with German government 10yr bond yields rising by 0.50% from July ’16 to March ’17 and Irish 10yr bonds rising by 0.70% to 1.03% in the same time-frame. In spite of this selloff in government bonds, yields remain at extreme lows compared to the long term average.
As an aside because we all quite rightly watch what’s happening in the US economy, inflation has started to appear on the radar of investors on that side of the Atlantic. Consumer price inflation there is running comfortably above 2% and the Federal Reserve is widely expected to increase official rates later this month to a range of 0.75-1%, also an extreme low compared to the long term average.
What can you do about it?
This is something you should be discussing with your independent financial adviser. You should be aware of how your pension, savings and other assets are invested ; how you might be exposed to higher interest rates and ensuring that you are diversified.
Some people may want to consider an allocation to so called real assets – investments that traditionally preserve value in times of higher inflation. Examples might include Inflation linked government bonds, property, infrastructure and gold.
We live in uncertain financial times, overshadowed by a new US presidential administration, Brexit, shifting politics across Europe and many other factors. We are not predicting a sudden change in European interest rate policy, but highlighting that inflation is something that should be monitored closely, and pointing out that market interest rates can move quickly to re-price expectations.
Independent Financial Adviser.
Ardbrack Financial Ltd
Disclaimer: The content of this article is for general information purposes only. It does not constitute investment advice as it does not take into account the investment objectives, knowledge and experience or financial situation of any particular person or persons. You are advised to obtain professional advice suitable to your own individual circumstances. Ardbrack Financial Limited makes no representations as to the accuracy, validity or completeness of the information contained herein and will not be held liable for any errors or omissions.