Inflation: A fleeting feature or a permanent problem?
Analysts across the globe are observing current economic recoveries with awe. What are we to expect when recovering from an iconic COVID-19 induced recession, comparable only to rare and distinct moments in history? It is almost impossible to know what a ‘normal’ economic response would look like. Economists are reminding each other to be patient with forthcoming data before changing any policies in case we get something wrong and trigger a financial disaster. Nevertheless, many criticise central banks for their apparent inertia in confronting one of the most formidable fiscal challenges of a lifetime. While we will not claim to know the answers we patently need, this article will explore some recent discoveries and summarise current speculations of those in power.
The US Federal Reserve saw an increase of 0.8% in the Consumer Price Index (CPI) MoM in April 2021, setting the stage for a potentially scary surge in inflation as the year continues to return from the COVID-19 lockdown. Core inflation, listed as all items excluding volatile commodities such as food and energy, rose 3.0%. The USA saw a surge in used car prices, up 10% MoM in April this year, and energy prices spiked also—together, the two commodities accounted for 48% of the spike in inflation. This has led many to anticipate inflation levels to exceed the Federal Reserve’s target of 2%. Officials of the central bank insist that the inflation is transitory, positing that inflationary pressures will start to ease from Q3 2021 as the balance of supply and demand begins to equilibrate and consumer behaviour adjusts to post-pandemic practices. We can see changes in various types of demand already, with airline fares up 10.2% MoM as well as demand for lodging away from home increasing as the economy reopens. This obvious pent-up demand and prospective increased mobility will be contributing to the expansion of consumer prices, resulting in the current 13-year high in US inflation. Federal Reserve Chairman Jerome Powell has nevertheless reiterated repeatedly that the spike will be short term, apparently offering confidence that raised interest rates will be unlikely, as well the prospect of tapering the asset purchase program. But what does this trans-Atlantic experiment tell us about the domestic climate in the UK?
Just like the US, the UK is suffering from a labour shortage, with retailers struggling to employ as many workers as expected as the economy reopens. We have also experienced a similar increase in fuel prices just like the USA, reaching the biggest increase since January 2020. Transport and clothes consumer prices have also increased. This has amounted to a YoY increase of inflation of 0.7% in March against a 0.4% increase in February, and core inflation rose to 1.4% from 1.1% in November 2020. The global factoring industry has been harshly affected by the COVID-19 pandemic; Europe accounts for around 68% but saw an overall decrease in factoring close to 7%, and other nations have similarly experienced mitigation. The current outlook paints a similar picture to our partner across the pond, with inflation generally rising. Our central bank also expects the inflation to be transitory despite factors such as hesitancy to return to work and supply-chain problems, expressing optimising that consumer behaviour will settle down. Nevertheless, the UK GDP fell 20.4% in Q2 2022 (the largest since records began!) and the European Stoxx 600 closed lower over the last weekend (with a particular loss incurred by leisure and travel stocks), ossifying scepticism of a typical steady return to normal. As commodity prices continue to rise, we may see a prolonged inflation, with some expecting inflation to rise beyond 4% by Q2 2022. Such projections are scary, but we can rest assured that no-one truly knows what to expect; a convenient return feels just a likely as a rocky recovery.
What should we expect? The fact of the matter is, COVID-19 slammed western industries hard; as liberal democracies with economic strength, the USA and the UK boast a positive outlook for a post-pandemic recovery but cannot ignore maladies on the economy such as declined demand for work and supply-demand irregularities. That said, it is understandable why central banks perpetually insist only a transitory inflation. We can only wait for upcoming data before any policy alterations, such as increased interest rates, will come into effect. It does feel slightly unreasonable, however, to expect no inflation to incur after a global recession such as this one. It would be naïve to think that supply-demand dynamics would remain as lubricated as in peace-time. We should prepare for the worst, but hope for the best; Keep Calm and Carry On.