The one theme that has dominated conversations with clients over the past few months is inflation and, more specifically, the possibility that it is about to take off. There are several strands to these concerns.
On one level, there are fears that a combination of persistently large government budget deficits, alongside an institutional softening of attitudes within the world’s major central banks, will pave the way to an era of much higher inflation which lasts for years, if not decades. As we’ve argued before, there is something to this, although the risks vary between countries and comparisons with the inflation of the 1970s are generally overdone.
A more immediate concern, however, is that the lifting of pandemic-related restrictions will unleash a surge in demand that firms will struggle to meet, thus putting upward pressure on prices and generating a burst of inflation. In this regard, the April PMI surveys (released last week) may have provided a taste of what is to come. A common theme across all countries and regions was a lengthening of supplier delivery times and a rise in input and output price balances. Add in continued increases in global commodity prices, and all the ingredients for a rise in inflation are there.
Before the pandemic, monthly CPI releases tended to pass without much comment. Now they will be scoured for any evidence of a post-pandemic jump in inflation. But what should investors be watching for over the coming months? Three things stand out.
The first is evidence of what might be termed “opening up” inflation. This is likely to appear in goods and services for which there is a surge in demand as restrictions are lifted such as hotels, restaurants, airfares and clothing. The extent of pent-up demand in these areas means that, even in the best of times, supply might struggle to keep pace. But in some areas – restaurants, for example – continuing social-distancing measures will compound the demand/supply imbalance.
The second is evidence of “opening up” disinflation. Some goods, including IT equipment and groceries, saw sharp increases in demand and prices as people were forced to stay at home. It follows that these components should see the reverse of “reopening inflation”: price pressures should ease as demand starts to level off. In some cases, however, the severe supply shortages that were created by a surge in demand during the pandemic are likely to linger for many months and limit the extent of any disinflationary pressure. This is particularly true of consumer electronics.
The final area to watch is evidence of “commodities-related inflation”. Oil prices have recovered from their slump at the start of the pandemic and metal and grain prices have surged far above pre-pandemic levels. These developments are already boosting inflation and will continue to do so in the near term. The extent to which they exert further upward pressure on inflation beyond the next six months or so will depend on whether the increase in commodity prices is sustained. Importantly, since inflation measures the change in prices from a year ago, it is the pace of any future increase that matter. Commodity prices have to continue to increase at their current pace in order for the impact on inflation to be sustained. If they level out – never mind fall back, as we expect – the effect on inflation will move from significant to neutral in 2022.
The task of tracking these different shifts is complicated by the effect the pandemic’s disruptions have had on calculating inflation data. On a practical level, statistics offices have faced the problem of having to measure prices when many items are simply not available for purchase due to lockdowns. They also need to account for shifts in the timing of seasonal sales caused by the pandemic. And they must grapple with a shift in consumption habits due to lockdowns which then needs to be reflected in the weights within inflation baskets. All of this means that “measured” inflation, which is to say the monthly figure reported by statistics offices, may differ from the true rate of inflation on the ground.
With all that said, we have created a dashboard to help clients track the evolution of inflation as economies open up. These will sit on our data and analytics platform, CE Interactive, and can be downloaded for use in clients’ presentations. (If you would like to learn more about CE Interactive, click here.)
The most important conclusion from our analysis so far is that there is much greater scope for a rebound in inflation in the US than in Europe or Japan. This is due in part to distortions caused by measurement issues. The fact that US states imposed relatively light-touch lockdowns meant that the statisticians were better able to capture the full extent of price falls in categories most affected by pandemic-related restrictions, such as airfares. In contrast, their counterparts in Europe were forced to impute prices for items that could no longer be purchased. This meant that measured prices for these items fell in the US but didn’t in Europe – meaning there is now much greater scope for measured inflation in the US to rebound as restrictions are lifted.
But the scale of fiscal stimulus in the US also makes it more likely that a rebound in “reported” inflation does not prove as transitory as many expect, including members of the policy-setting Federal Open Market Committee. Instead, it seems more likely that supply fails to keep pace with demand, thus keeping core inflation elevated over the next couple of years. It goes without saying that we’ll continue to monitor events closely and will update our dashboard on a regular basis. But we expect that US inflation data will make for increasingly uncomfortable reading over the coming months. If that’s the case it will test the Fed’s commitment to keeping policy support in place.
In case you missed it:
- Marcel Thieliant, who leads our Australia research, assessed the extent of pandemic scarring on the Australian economy.
- Property Economist Amy Wood showed which European cities will be most affected by the shift to working from home.
- Senior Europe Economist David Oxley explained our thoughts on the timing of a rate hike by the Norges Bank, which would be the first of the advanced economy central banks coming out of the pandemic.