RESEARCH UPDATE: INFLATION
Concerns have also been expressed about the resultant outlook for inflation. These were heightened on 12 May when market sell-offs were triggered by the US Consumer Price Index (CPI) for April. This showed a 0.8% month-on-month increase against an expected 0.2%, pushing the year-on- year increase to 4.2% – the biggest rise since September 2008 – and way above economists’ projections of 3.6%. The core inflation figure, showing a 0.9% monthly increase, was also worrying, representing the fastest pace of core price rises since September 1981 and giving an annual figure of 3%, the highest in 25 years.
Trouble ahead
Deutsche Bank Research’s Chief Strategist Jim Reid warned5
that the data signalled
trouble ahead. “You may get dull periods, but this year is going to be a big battle between the bullishness of mass reopening/ stimulus on one hand and the inflationary consequences on the other,” he wrote.
In their Inflation Outlook, the US, Euro area and UK (April 2021) report,6
Deutsche Bank
analysts note that US inflation remained weak and had been “slipping in sectors at the epicentre of the Covid shock”, although related supply-and-demand-sensitive contributions to inflation had been declining since the early months of the pandemic. Before the April data, core CPI inflation had nonetheless kept well below the Federal Reserve’s (Fed’s) 2% target and was not expected to reach it until the end of 2021 – and then modestly exceed it.
In addition, says the report, “Inflation expectations have begun to pick up on the Fed’s reaction function, more robust recovery, and stimulus”. As flow reports in ‘Inflation genie drivers’ (26 February 2021),7 there are concerns that the Fed is too relaxed about the prospect of US inflation remaining subdued post-pandemic.
Managing low inflation In Europe, “the pandemic hit inflation hard in 2020, pushing headline Harmonised Index of Consumer Prices down to 0.3%,” report analysts. Although currently both the unemployment rate and underlying inflation remain far from pre-crisis levels, analysts see core goods inflation picking up in the months ahead on the back of rising supply costs.
However, this is not enough to solve the euro area’s “low inflation problem” they suggest, as the labour market remains a long way from its pre-crisis health. “Without a material
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flow.db.com
7
shift in worker inflation expectations or non- accelerating inflation rate of unemployment, the wage outlook will remain tepid and translates into persistent low services price inflation.”
Core inflation, forecast at 0.7%–0.8% for both 2021 and 2022, is predicted to edge back to 1.2%–1.3% in the subsequent three years, although this is still well below the European Central Bank’s (ECB’s) 2% target.
The one-time Next Generation EU recovery fund, set up at a July 2020 summit with a €750bn budget to facilitate post-pandemic recovery in the eurozone, will begin disbursing funds in mid-2021, with up to €85bn likely to be distributed in H2, and at least twice that figure in 2022.
In September 2021, the ECB is expected to announce the results of its first Strategy Review since 2003, and analysts are releasing a series of notes8
ahead
of publication. They expect the ECB to confirm that negative interest rate policy, targeted longer-term refinancing operations, quantitative easing and forward guidance remain its key policy tools. “The question is whether the ECB can clarify details and boost confidence in this toolbox.” Around the same time, the ECB will decide whether it needs to “extend the main pandemic policies beyond their current expiry dates in the first half of 2022”.
The ECB’s numerical definition of the inflation target is currently worded as “close to, but below, 2%”. Analysts suggest this may be raised slightly to 2%, which “would make the target much clearer and easier to communicate”.
Asia’s spike In Asia, analysts single out9
China, Taiwan
and Vietnam as the only countries likely to see their economies surpass pre-Covid trend levels in 2021, as “much of the [2020] output loss is expected to be permanent for most of them, although they may return to pre-Covid growth rates”. With this negative output gap likely to persist over the next year, they see a “near-term spike in headline inflation [that is] unlikely to lead to significantly higher core inflation”.
Surveys of Chinese and South Korean households indicate only modest expectations for higher wages, and average inflation is forecast to rise from 1% to mid-2% in H1 2021, before subsiding again in H2.
India is a notable exception, where “core inflation has been stubbornly high at about 5%”. The Reserve Bank of India (RBI) is expected to respond by withdrawing emergency liquidity support and making small increases to the repo rate. Although India has experienced a sharp rise in Covid-19 cases since February 2021, the RBI expects real GDP growth of 10.5% for the year to March 2022.
Sources 1 See
https://bit.ly/2QOBwOQ at
flow.db.com 2 See
https://bit.ly/3oJgb5C flow.db.com
3 Germany Blog: Government Will Present Another XXL Supplementary Budget (23 March 2021)
4 UK Weekly Digest (1 April 2021) 5 Early Morning Reid (13 May 2021)
6 See Inflation Outlook, the US, Euro area and UK (April 2021)
7 See
https://bit.ly/2RFrFev at
flow.db.com
8 ECB Strategy Review: Scoping out the Landing Zone (9 April 2021)
9
Focus Europe: Inflation Dashboard – Global vs Domestic Risks (25 March 2021)
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