Pension funds in the DACH region are gearing up to face a potential increase in inflation rates resulting from monetary and fiscal policies implemented to fight consequences of the COVID-19 pandemic.

“My personal standard scenario sees a higher probability of an increased US inflation in the short-term – in the next three to six months – due to a base effect. Then in the next two years inflation might be around 2%,” Stefan Beiner, CIO at the Swiss public pension provider Publica, told IPE.

The probability of higher inflation in a three to five year period has clearly increased, he added. Publica invests in inflation-sensitive assets such as gold, silver, inflation-linked bonds, real estate assets in Switzerland and abroad.

The pension fund can also take tactical decisions to position itself within a short-term time horizon of three to 12 months, the CIO explained.

“In the last months we have overweighed inflation-linked bonds compared with nominal bonds in our portfolio because we anticipated inflation to increase,” he added.

Publica will review its investment strategy at the beginning of next year, by assessing as usual different scenarios, including a deflation and a hyper-inflation scenario.

“We aim for a high diversification [of assets] that takes into account different inflation and gross domestic product [GDP] scenarios,” Beiner said.

For the Pensionskasse of the Swiss federal railways, SBB, rising inflation and interest rates “are positive in the long term”, Dominik Irniger, head of asset manager, told IPE.

“We were already positioned, before the COVID-19 pandemic, for rising interest rates in our long-term strategy, nothing has changed about that,” he said.

SBB expects inflation to rise over the next one to two years but to a limited extent, while interest rates will level off at a slightly higher level than today. Central banks may decide to increase interest rates depending on inflation and the level of employment.

“The Federal Reserve has signalled that an inflation rate over its target is tolerable for a certain time period, [but] if it goes out of control, to 5% or 6%, then it will try to contain it. Whether this will be easy to navigate, is questionable,” Beiner said.

Fed building

The Fed expects inflation to go up to 2.4% in 2021, above the 1.8% projected in December, and go back to 2% in 2022 and 2.1% in 2023

The Fed expects inflation to go up to 2.4% in 2021, above the 1.8% projected in December, and go back to 2% in 2022 and 2.1% in 2023.

Inflation becomes “particularly problematic” for the Bayerische Versorgungskammer (BVK), Germany’s largest public pension fund, if central banks continue to keep interest rates artificially low, a spokesperson said.

BVK has “massively increased” its allocation to value investments in recent years at the expense of nominal bonds.

“Therefore we feel that we are well positioned for an upcoming inflation [hike],” the spokesperson said.

Since BVK is legally required to invest part of its new funds in nominal value investments, it sometimes uses variable-interest securities such as collateralised loan obligations (CLO), and considers inflation-indexed bonds, the spokesperson added.

Central banks’ monetary policies and fiscal stimulus from governments to propel economic recovery following the pandemic adds to fear of inflation shooting up.

This leads to a high level of liquidity for consumers, which cannot be spent because of current restrictions, creating “consumption congestion”, the spokesperson added.

“On the other hand, companies postponed investments and capacities were cut. If the situation normalises, it could lead to excess demand and thus inflation: This applies to both the US and Europe,” the spokesperson said.

Austria’s Valida expects inflation will continue to rise over the coming months due to the base effect. The base effect becomes clear if looking at how last year’s prices for raw materials developed, or the drop in oil prices, Martin Sardelic, the CEO of Valida Pensionskasse, told IPE.

Martin Sardelic at Valida

Martin Sardelic, Valida

“Inflation in the euro zone should go in the direction of the ECB’s inflation target, while in the US it will probably go slightly above the long-term target of the Federal Reserve,” he added.

The European Central Bank forecasts inflation rising to an average of 1.5% in 2021 from 0.3% in 2020. Inflation will peak at 2.0% in the fourth quarter of this year to drop back to 1.2% in 2022, before rising to 1.4% in 2023.

“Valida has added so-called inflation linkers, namely inflation-indexed bond funds, in both euros and US dollars to its portfolio in view of expected inflation [hikes] and the associated interest rate speculation,” Sardelic said.

Valida routinely assesses its investment portfolio through its tactical asset allocation on how markets could change faced with interest rate speculation or central bank measures based on the development of the inflation, the CEO added.

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