By David Clark

For any firm of investment managers like Saracen the big topic of the month (leaving aside the tragedy unfolding in the Ukraine) is inflation. It dominates headlines and its invidious power affects all aspects of everyday life.

Utility bills are high and going higher, as are food prices. It now costs more than £100 to fill a standard 55-litre car petrol tank and people’s savings are diminishing in value.

Not to worry, though, because we know we have some of the biggest brains on the planet in charge of our economies and at the helm of the Bank of England and the US Federal Reserve. They know what is going on, they know their history and they know the levers to pull to make everything right again.

I’m afraid it may not be as easy as all that. To understand why this might be it is important to get a handle on why inflation has made its way back into the national conversation. There are,

as I see it, two schools of thought.

Firstly, inflation has essentially been caused

by the politicians spending too much. Higher inflation follows higher spending just as sure as the weather forecast follows the news.

Government spending in the UK is as high a proportion of GDP (gross domestic product) as it has ever been. The past few years have seen governments printing lots of money while at the same time locking down society and businesses, forcing economic output lower. To make matters worse they kept throwing more money at the recovery in an effort to speed it up. That was

a blunder.

Which brings me to the second theory of why prices are appreciating as they are now. This is

a shocking oversimplification, but it is because the market has suffered an exogenous shock. The Russian invasion of Ukraine has forced energy and food prices up.

Andrew Bailey, Governor of the Bank of England, and Prime Minister Boris Johnson can point at Russian President Vladimir Putin and say, “It’s not our fault – it’s his.”

The problem with both of these scenarios is they are not mutually exclusive, no matter how much some might want them to be to suit their own purposes.

Now the question is whether the UK will enter a recessionary period with all the hardship that brings. In my view, the Bank of England has made a recession not only inevitable but have likely ensured it will be deeper and perhaps longer than it otherwise might have been. They have done this by aggressively raising interest rates by 50bps following the Fed’s rise of 75bps.

I have no problem with interest rates going up to address the strong labour market and dampen demand but, when I was at university, I am sure

I was taught that using interest rates to combat shocks to the economy did not work, as was evidenced in 1973 when rates were increased in response to the oil crisis to prevent inflation. In fact, it led to stagflation that dominated much of the 1970s.

It is not that long ago the Bank of England and the Fed were trying to have us believe any rise in inflation would be small and transient.

These rate rises smell like panic to me and

that is never good. I believe it was Sir Winston Churchill who said: “Those that fail to learn from history are doomed to repeat it.”

There is now every chance the combination of higher energy prices and the pace of rate increases will force the economy into a recession the policymakers have helped create.

If the mistakes of the 1970s have been made in 2022 then perhaps we should be asking what the solutions were then.

As households felt the squeeze there was

a commensurate increase in consumer borrowing that only exacerbated the supply/demand imbalance in the economy. So much so the Government had to impose strict limits on consumer credit to return to a sustainable and non-inflationary equilibrium.

If a similar situation was to arise again such limits would be more difficult to enforce and control as borrowing is becoming ever easier. There are new and clever apps, banks are still issuing credit cards hand over fist and new fintech companies are devising ever more scary ways of buying goods now and paying for them later.

If all of this has not unsettled you, then I have not explained it very well. It seems all but certain the macroeconomic picture on both sides of the Atlantic is going to get a lot worse before it gets better making the job of a fund manager ever more challenging.

Nobody said it would be easy.

David Clark is investment director at Saracen Fund Managers.