Inflation rears its head again

Ted Scott, Manager of the F&C UK Growth & Income Fund, comments: “The rise in the Consumer Prices Index (CPI) to 3% is the highest for 11 years but it did not come as a surprise following the unexpected increase in interest rates last week.

“In fact, the market was relieved that, firstly, it did not breach 3%, which would have required Mervyn King, Chairman of the Monetary Policy Committee (MPC), to write an explanatory letter to the Chancellor. Secondly, it revealed why interest rates were raised last week and did not conceal something worse.

“The recent acceleration in inflation is however unwelcome. There must now be a real chance of further rate rises this year, especially as the Retail Price Index (RPI), that includes mortgage interest payments, hit 4.4% and a lot of wage increases are priced off this higher measure. The MPC is also keen to see the housing market cool off following the buoyant market in the latter part of 2006. Considering the momentum of inflation, a further rise in rates before the summer is probable.

“Equities have remained resilient as the economy has continued to grow strongly and company profits have generally met or exceeded expectations. Also, a little bit of inflation is generally good for equities as they are a hedge against rising prices and enable companies to have greater pricing power. However, if and when the economy and, therefore, company profits are adversely affected then equities will draw breath. As bond yields are rising the attraction of debt financed M& A deals will diminish and this has been a major prop for the market in recent months.”