The UK inflation-linked government bond ('linker') market is dominated by vast UK defined benefit pension schemes. Derisking by schemes tends to increase demand for linkers as equity prices rise, pushing up their prices. For multi-asset investors seeking diversification, that could make them less attractive to buy.
In November, the Bank of England decided not to go beyond reversing the 'insurance' rate cut it made following the EU referendum. Since then, however, the UK labour market has improved and inflation has remained stubbornly high. This presents the governor with a conundrum. Should he raise rates again soon or remain cautious and wait for the fog of uncertainty regarding the final Brexit deal to lift?
On Friday, we are likely to receive confirmation that Chinese inflation jumped to almost 3% in February, up from 1.5% previously. Higher Chinese inflation conjures up scary scenarios. It could force the People's Bank of China into hiking interest rates when the economy is slowing and saddled with massive debt. It could also add to building inflationary pressures in the US and UK, hastening interest hikes and weighing on equity and bond prices. But relax! The jump in Chinese inflation shouldn’t trigger any of this.
Unlike their US or Eurozone counterparts, UK pension funds will readily pay quite a premium for inflation protection. However, that premium is relatively unattractive for multi-asset investors, who we think can find better ways to manage UK and global inflation risks.