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Inflation surprise as the economy prepares to come back from COVID

For a UK economy with a record of low growth, a little overheating may be welcomed.  Officially, the Bank of England and other central banks agree on stimulus and seem to be unworried by inflation. But the stimulation is in uncharted territory; inflation is likely to surprise on the upside. This is alongside an expectation of sharp upturn in industrial sector earnings that should persist for at least two or three years. Pointing to this, inventory and capital spend hit lows in the second half of 2020, a position that often leads to industrial recovery. We can expect more signs of overheating to emerge, and signs of supply disruption in a range of sectors. Companies with pricing power will be able to pay up for their inputs and raise wages.

Differing responses to the pandemic around the world are beginning to create political tensions. Maybe not yet a new world order, but regional power has shifted. China has gained influence and is more in control of its own destiny: the US less so. The next phase of China’s development may not be export-led but instead focus on boosting domestic demand. A rise in global food prices could be the result, exporting inflation that will feed into wages in the West.

Adding to soft commodity pressures, the shift towards electric vehicles and renewables are likely to bring a structural increase in demand for copper and some other commodities. The move from conventional power generation will bring a step-change in copper intensity.

US stimulus is experimental, not only in terms of the level of stimulus but the degree of control on bond prices that is being attempted. The US Federal Reserve may no longer have the authority to dictate to global investors in this way. Buyers of US debt could decide to impose more financial discipline. Huge global stimulus should boost company profits over the next two years, but it could bring more volatility in currencies and interest rates. In this recovery, the focus within industrials should be on businesses with the potential for earnings quality to be recognised and re-rated as profit growth comes through.