• Inflation comments suggest rate rise could be some way off
• Positive back-drop for risk assets as investors search for yield

The factors that have driven CPI inflation over four per cent are temporary and likely to fall away, John Greenwood, chief economist at the fund manager Invesco Perpetual, has said.

A ‘change in the composition’ of inflation is causing the level to climb significantly over the Bank of England target, rather than reflecting embedded inflation, Greenwood said.

“The cost of what we import is increasing rapidly but what we export is not increasing so rapidly,” he said.

This has been driven by higher prices for commodities such as oil, while the rise in VAT at the beginning of the year continues to be felt. Greenwood said underlying monetary growth, such as levels of household credit, are at historic lows, suggesting the inflation spike is transient.

‘Commodity price surges’ are typical of a period of economic recovery while prices could be reaching a peak level, partly depending on how much emerging market economies tighten monetary policy to deal with domestic inflation issues.

Economic growth

“The difficulty in developed economies is that balance sheets in the financial sector, household sector and now in the government sector are urgently in need of repair,” Greenwood explained.

This means households and companies are trying to pay down debt and banks are reluctant to lend. “Because of that monetary policy has not been effective,” he added.

Normally in a low interest rate environment borrowing and credit are boosted, helping to generate economic growth.

Invesco forecast that the UK economy will grow by 1.5 per cent in 2011. At the time of the Budget earlier this year the Office for Budget Responsibility said it expected 1.7 per cent growth.

Interest rates

This outlook suggests an imminent rise in interest rates is unlikely. Subdued economic growth and an expectation that inflation will fall away going into 2012 would weaken the argument for a rate rise.

Investment outlook

Greenwood said the current backdrop of low interest rates and ‘sub-par economic growth’, as the UK recovers from the economic crisis was positive for bond and equity investments.

He said the current climate was prompting a ‘search for yield’ amongst investors in developed economies.

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