Friday, 30 September 2011

And Now for Some Good News - Low & Stable Inflation Expected

Amongst all the big market swings and dire news of countries at risk of defaulting on debt, there's one key economic variable whose outlook is relatively benign that is of crucial interest to investors - future inflation rates.

Big unexpected leaps in inflation that hurt both stocks and bonds do not seem to be in the cards at the moment, despite the latest CPI figures from Stats Can for August which showed a still-high rate of 3.1%.

The future according to:

Bank of Canada - The organization responsible for monitoring and controlling inflation in Canada states that its
The Market - By subtracting what investors are willing to pay (accept as a return) for inflation-indexed Real Return Bonds from ordinary non-inflation indexed Canadian government bonds of similar maturity, we can infer the market expectation of inflation. Reuters thankfully has been doing the tracking for us in the Canada Breakeven 20 Year chart, the update as of September 29, 2011 shown below. Note how expectations have varied quite a bit in the last five years, though never going above about 2.8%.

  • current expectation 2.08%
Best future inflation estimate: 2%

How likely is it the forecasts will be correct?
We all know how prone to error forecasts can be. CanadianFinancialDIY blogged about a Credit Suisse report that surprisingly found central bankers to be the most accurate though they too erred by more than 1% above and below the eventual real rate.

What does it mean for the investor? Low and, especially, stable inflation would remove a major troubling element for investors as inflation is a potentially very nasty risk (see our recent post on how how bad inflation and its effects have been in the past). Despite the good forecasts it may still be wise to be cautious and hedge bets by building inflation protection into a portfolio, as we discussed in Investments to Protect against Inflation and in Investing Risk: What is there to Lose?

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

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