It has not taken much to revive fears about inflation. But instead of the full electric-bolts-through-the-neck-and-a-lightning-strike type of resuscitation when these things come along, it is more of the quick-flick-behind-the-ears-with-a-wet-piece-of-cloth type of rebirth.
In recent months, financial analysts and economists alike have been pushing and falling over each other to lay out whether we are going to see increased inflation in 2021 or not. The trepidation has been building for some time—in May, the Associated Press even put out a primer as to why these fears had been resurrected.
Expert Investor has run stories on inflation, too, recently, including this contributed piece by BNP Paribas.
Not long ago, I interviewed a number of people for a piece for Public Finance on this very issue. One of them was Carsten Brzeski, chief economist at ING-Diba. Brzeski told me, unequivocally, that he thought there would be dramatically increased inflation this year. “There should be inflation of 3-4% in the second half of 2021, but that will come down again over the next 12 months.”
Brzeski is not the only one to have made such a prediction. John Williams, president of the New York Federal Reserve told the Women in Housing and Finance Annual Symposium something similar in May. Back then, Market Watch quoted him as saying that inflation would go above 2%, but would fall. “While I am optimistic that the economy is now headed in the right direction,” he is reported to have said, “we still have a long way to go to achieve a robust and full economic recovery.”
All of it has been felt in the market, which have been reacting accordingly. According to our sister publication, Portfolio Adviser, even back in February investors were seeking out ways in which to protect themselves against increasing inflation.
As my esteemed colleague and overall nice guy Sebastian Cheek put it, “A combination of huge fiscal stimulus in reaction to the coronavirus pandemic and pentup demand as economies emerge from lockdowns has the potential to cause a short-term inflationary spike, and spooked fund buyers are preparing their portfolios accordingly.”
So it should have been little-to-no-surprise that the European Central Bank changed the definition of its own inflation target a few days ago. As The Guardian reported: “After an 18-month review, the central bank for the 19-member eurozone said it would shift its inflation target from ‘below but close to 2%’ to a 2% target it said was easier to communicate to financial markets and the public.”
That is a change that is both small and significant, and one that recognises the shifting economic landscape. As industry and economies begin to pick up speed and move through the gears of reopening, it will be like packing up and leaving a beach at the end of the day. There is a lot, accumulated slowly and almost imperceptibly, that will need to be shaken out of this blanket.
The Guardian also picked up some of the ECB’s justification for the change.
It reported: “The ECB president, Christine Lagarde, said the new strategy was simpler to communicate and ‘a strong foundation that will guide us in the conduct of monetary policy in the years to come’. She denied the central bank was ‘moving the goalposts as prices begin to rise’, saying the review was started long before the recent recovery and strong increase in inflation. She added that ECB council members always considered the inflation target to be ‘very close to 2%’ and the change was only modest.”
It is a good rule of thumb that you should check the alignment of posts and painted lines on a football field when someone tells you that they are not moving the goalposts.
Close to the vest
The ECB is still being conservative about future inflation. A few days ago, Reuters reported ECB board member Isabel Schnabel telling the Frankfurter Allgemeine Sonntagszeitung that, ‘[…] we will not experience any excessively high inflation’.
That statement had all the reassurance of asking a burglar to water your plants and them promising not to steal from your house while you are away. All of this came among other reports from Reuters that some policymakers within the ECB fear inflation is more durable than predicted.
Still, Schnabel was being coy about the ECB’s change in the inflation target. “On the one hand, the increase in the inflation target is minimal,” she told FAZ. “On the other, the goal of 2% has an important function: It creates additional room for our monetary policy to have a stabilising effect.”
Choppy waters ahead
Given that we seem to be heading into a time and space when inflation is running high, what can we expect?
Well, it depends if there is agreement on whether the inflation will be short lived or not. And, right now, there seems to be little consensus on that at all. The thinking so far is that the underlying effects of the pandemic on the economy—supply shortages, people working from home, et al—have yet to be worked out of the system. And there is the argument that once they are worked out that secondary inflationary pressures may arise.
These may include an increase in wages once people go back to work full time after the various furlough and government support schemes are tapered off. This may bump inflation up again, and even higher if the predicted bump has not yet abated.
So, yes, we could see some turbulence in the economy and whatever comes next is going to need careful management.
None of this is entirely predictable, though. None of life is. Who could have predicted once that a player flubbing a penalty in the semi-finals of a European cup would return 25 years later as the manager of that same national team, leading them into the finals of that same tournament? Predicting what will happen in the economy may be a fool’s game and it is a role that belongs to people much more experienced than I. The only thing I can predict with some clarity is that when it does happen, it will be interesting to watch.