Temporary inflation rebound | Very likely: Energy-related base effects, plus the reversal of the VAT rate cuts in the UK and Germany, are likely to push consumer prices higher this year. The recovery in oil prices and rising shipping costs are additional factors. What’s more, pent-up demand meeting supply bottlenecks for a range of big-ticket items and services should provide a further boost for some time. Imagine that your ski holiday got cancelled, given lockdowns and travel restrictions. You really need a break at this point and are willing to pay more this summer – especially as you’ve been ‘forced’ to stay in and, therefore, save more than you’d have liked. Unfortunately, not all resorts made it through this tough period and those still in business can’t afford to cut prices. If anything, they may have no choice other than raise them.
Sustained inflation surge | Quite uncertain: A long-term cycle of rising consumer prices doesn’t seem particularly probable for the time being. With so much slack in the labour market, wages are unlikely to pick up momentum any time soon – so firms won’t need to raise prices to offset higher cost pressures. This seems to be the case especially in Europe, where compensation per employee is almost stagnant and inflation expectations remain rather low. Things look better in the US, as pay growth looks more resilient and inflation expectations have already risen quite a bit. More structurally, the combination of technological innovation in the field of automation plus ageing could be quite deflationary over the longer term, more than offsetting hypothetical upward cost pressures if global supply-chain disruption turned out to be protracted.
Here’s why this matters:
Stimulative policy mix here to stay: Central banks built their price-stability credentials in a world where inflation was high and rising fast – and, technically, there’s no limit to policy tightening in the form of rate hikes. But they now worry about deflation risks and debt sustainability. Given that it has undershot for such a long time, the Fed and (soon) the European Central Bank are willing to tolerate, even embrace, moderately above-target inflation for some time. Whether we’ll soon get there is an open question. But this doesn’t mean central banks will declare defeat. Rather, with policy rates at zero or negative, they’ll keep funding costs low for governments to continue to afford large stimulus programmes – after all, higher inflation, if it ever comes, will help them reduce their debt burdens.
Structural support for asset prices: Whether monetary conditions are stimulative or restrictive has to do with real rates. When they’re negative, monetary conditions are stimulative. When real rates are positive, they’re restrictive. Imagine that inflation were 3%. In this scenario, central banks would be able to raise nominal rates to 2% while still keeping real rates negative. But, with inflation so low, they’ll have to maintain very low nominal rates. In turn, this implies discounting, say, ten years of cashflows using lower rates than in past cycles. This boosts the present value of risk assets. Vaccines allowing reopening from the coming spring is the main thing that’s changing this year. But, like last year, the policy mix – which anchors real rates – is likely to stay very supportive.
Meanwhile, let’s look at what’s in store this week…
Less of a lockdown blow: The latest GDP numbers seem to confirm our assessment that the impact of renewed restrictions has declined significantly, probably due to greater adaptability of consumers and businesses, as well as continued policy support. Among the more timely ‘hard’ indicators, this Friday’s US jobs report is going to be the key one. Among the ‘soft’ ones, the purchasing managers’ indices for the US and China will be important to get a sense of their resilience across manufacturing and services – the numbers so far released point to a moderate loss of momentum, but positive growth nonetheless. The euro area is likely to have come out of deflation and German factory orders could provide some insight on the industrial front. The Bank of England will probably stay dovish, and there’s an outside chance of extra easing – though which form this may take is unclear.
Daniele Antonucci | Chief Economist & Macro Strategist
This document has been prepared by Quintet Private Bank (Europe) S.A. The statements and views expressed in this document – based upon information from sources believed to be reliable – are those of Quintet Private Bank (Europe) S.A. and are subject to change. This document is of a general nature and does not constitute legal, accounting, tax or investment advice. All investors should keep in mind that past performance is no indication of future performance, and that the value of investments may go up or down. Changes in exchange rates may also cause the value of underlying investments to go up or down.
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