Inflation – Cover story Leaving its mark
There is an outlook that states inflation is neither as problem- atic as suggested nor likely to be a simple reversion back to normality, after a blip of a transitory phase. Instead, the current inflationary situation could well to leave its mark. “The extreme extent of inflation is probably transitory, but we have also turned the corner on permanently low inflation,” says Stuart Trow, who has just retired as a credit strategist at the European Bank for Reconstruction and Development. If it is going to leave its mark, what can be cited as the biggest concern regarding inflation? “In the West it is what rising yields will do to asset prices and in emerging markets what ris- ing food and fuel cost will do to political and social stability. “In fact, many western nations will struggle politically with higher living costs, especially if they add austerity on top,” Trow says.
Doyle points to other issues that could fuel inflation. “Other factors that may prove more enduring in terms of their contri- bution to inflation are the likely peaking of globalisation, the greater role being played by fiscal stimulus in a post Covid world – as opposed to the dependence upon monetary policy over the last decade – and also the related matter of decarboni- sation. While this latter development will ultimately pave the way for cheaper renewable sources of energy, in the short-term the transition will potentially have an inflationary impetus,” she says.
As bad as it gets This raises a big question about how bad the inflationary pic- ture could get – even within a transitory scenario. “The exact level will depend on how the pandemic unfolds, but I can
imagine that towards the end of next year we might be talking about supply gluts rather than shortages as demand eases and some of the logistical issues are addressed,” Trow says. Giving his outlook, Jeffery says: “We see US core – excluding food and energy – inflation peaking at 6% in the spring before falling back again as some of the one-off re-opening effects wash out of the annual comparison.
“In the UK, we see a lower peak with headline inflation on a CPI basis peaking around 5%,” he adds. “At the best of times, inflation forecasts are a hostage to the fortunes of commodity markets. Given the wild swings in natural gas prices in recent months, and the uncertainty about whether the government will intervene, that is especially true today. Anybody’s inflation forecasts should be taken with a truckload of salt.” Jeffrey also notes that when it comes to the UK’s inflationary picture, it is important to monitor the labour market. “Most notably, the loss of jobs among the self-employed and part-time workers. As those people get drawn back into work, we expect to see further upward pressure on wage growth.” At the global level, there is a need to monitor the Covid situa- tion in China carefully, he adds. “The struggles to maintain a zero-Covid strategy in the face of the highly contagious Omi- cron variant pose a serious risk to global supply chains that could see another round of price pressures in the global goods markets.”
Behind the inflationary curtain
I fear that we will again fall into the trap of believing that inflation is a problem that can be addressed by monetary policy alone.
Stuart Trow, formerly of the European Bank for Reconstruction and Development
Understanding where this inflation came from, aside from the Covid pandemic, is important in understanding the wider infla- tionary picture, says Trow. “It is important to be clear about why inflation had been so low for so long and had been impervious to ever more extreme monetary easing measures to boost it. “It was the supply side shock of globalisation – rather than monetary policy – that kept a lid on wages and the prices of consumer goods,” Trow adds. “Western workers couldn’t com- pete, which is why real median wages have either flatlined or trended lower over much of the past 20 to 30 years.” On this scenario, even before the pandemic, however, the trade war with China, amongst other things, first slowed then reversed global trade growth. “That was one of the reasons Germany was almost in recession even before the pandemic began,” Trow says. “The reversal – or even just slowing – of trade growth has meant that higher cost solutions to supply chain vulnerabilities have had to be found and western workers are starting to rediscover their pricing power.” Put another way, James Brooke Turner, investment director at the Nuffield Foundation, says: “The idea is that Chinese manu- facturing has changed the inflation landscape for the past 30 years, but might not continue to change it over the next 30.”
Issue 110 | February 2022 | portfolio institutional | 21
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