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Salt economist warns on inflation shake-out

Bevan Graham has flagged inflation concerns in his first formal analysis penned as economist for new employer, Salt Funds Management.

However, Graham, who quit as managing director of AMP Capital NZ last August, says in his inaugural Salt ‘Global Outlook’ that while “there is a heightened risk of resurgent inflation over the next year or two, don’t expect central banks to respond immediately”.

He says central banks would probably look through the initial bout of price rises, citing temporary supply bottlenecks and the like, but a number of factors are conspiring to support more sustainable inflation.

For example, concerted central bank efforts to lift inflation expectations are finally paying off during a rare period of simultaneous loose monetary and fiscal settings.

As well, Graham says the wind-back of globalisation, a possibly permanent post-pandemic damage to supply and skewed employment trends would add to inflationary pressures.

Unemployment is now higher overall than before the COVID crisis, he says, but “we would argue the skilled labour market is tighter than it was before the pandemic, putting upward pressure on wages”.

“… we do see the risk of more sustained inflationary pressure in the period ahead. The New Zealand specific risks include recently higher inflation expectations, wage pressure emanating from skills shortages and the more permanent shifts in global supply chains that may result in more sustained price increases,” Graham says in the analysis.

“Add to that the fact that many of the core inflation measures the RBNZ monitors are closer to 2% and heading higher, there are sound reasons for them to be less dovish and more neutral in the period ahead.”

In the interim, though, central banks will attempt to hose down fixed income markets if they push rates higher too quickly, he said, first by “jawboning” and then with action such as the recent Reserve Bank of Australia bond-buying splurge.

And even if sustainable inflation looms into view, Graham said monetary authorities would have to wind back ‘unconventional’ policies such as asset purchases well before ramping up official interest rates.

“We’re not in a hurry to buy bonds,” he said.

Equities, meanwhile, continue to offer better return prospects with the ability to weather gradual inflation as long as corporate profits rise in concert, the Salt analysis says.

“Higher inflation remains a risk, especially if the nascent pressures we have identified take hold more quickly than expected forcing central bank responses and a wall of money rushing for a very small exit door,” Graham says in the outlook.

Property and infrastructure would continue to offer a “natural inflation hedge”, he says, as the sectors “almost always remain able to engineer revenue growth, as global mega-trends drive demand for them inexorably upwards”.

But active management would be critical for investors as they negotiate through this period of heightened uncertainty and rapidly changing conditions, Graham said.

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