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The inflation promise

An economic upturn could raise inflation. For equity investors, this would be a good thing
The inflation promise

Hopes that we’ll get a vaccine against Covid-19 next year have increased the chances that there’ll be a good economic recovery, which in turn raises the prospect that inflation will rise. Equity investors, however, should not fear this prospect.

For one thing, any increase in inflation is likely to be moderate. Yes, the Bank of England has been printing money. But as we learned in 2009, this is not necessarily very inflationary because this increased supply has been matched by increased demand. And insofar as that demand for money does recede, it is more likely to lead to rising share prices than to rising consumer prices.

Instead, the inflation threat, such as it is, comes from more mundane sources. It’s simply that there’s likely to be a degree of mismatch between unemployed workers and the vacancies that are available, while a swathe of business failures could increase the pricing power of surviving companies. A pick-up in demand might therefore raise prices even while there appears to be lots of spare capacity in the economy. History tells us this does indeed happen: inflation rose soon after the recessions of 1991-92 and 2008-09. But it also tells us that such rises are shortlived, and inflation falls back as the mismatches fade away.

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