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The Big Bad Inflation


Winter is not coming, it’s already here. 

Several economies are experiencing high inflation rates as a result of the immense fiscal response used by governments to combat the Covid-19 crisis.

Around the world, inflation is breaking central bank targets. With US inflation at 5.4%, UK inflation hit 2.5% and even New Zealand, the Covid success story, was above its target inflation band.

As lockdown restrictions ease, the uptick in consumer spending has contributed to pushing prices higher. Indeed, high levels of government spending as a response to the crisis leads to increased jobs, which in turn creates more income and increases consumers’ propensity to consume.

Increased levels of inflation can be a concern for consumers however, as higher prices entails an increase in costs of living. High levels of inflation are also a concern for investors, as their returns are now worth less.

In fact, many fund managers are looking for ways to shield their portfolios against inflation, and have resorted to the property market and cryptocurrencies to do so. Business owners also report having to pay higher wages to their employees in an already tight job market.

These investment decisions have manifested over fears that central banks will raise interest rates to slow down the economy and hinder recovery. In fact, a governor at the Russian central bank warned that the Russian central bank is likely to toughen their monetary policy stance as public inflationary expectations soar.

However, a silver lining of the high inflation rates is that they reduce the burden on government debt. It is down to central banks to balance the needs of the government and private investors.

Central banks in advanced economies claim the current global inflation to be transitory and stress that the latter doesn’t worry them. In the United States, the Fed has recently adapted their inflation targeting strategy, claiming that their 2% target is not a ceiling but rather, an average that inflation should fluctuate around.

However, consumers and investors alike remain cautious, as throughout history, all sustained periods of inflation were claimed to be temporary.

Does this affect everyone?

It depends on where you are and also the time frame. These high levels of inflation seem to be evident on either side of the Atlantic. Of course, high inflation rates in one economy can have spillover effects into other economies.

When looking at global trends and predictions, views vary, as inflation in much of the developed world is beginning to fall, leaving many with the opinion that the rising rates were only in the short-run.

Source: Deutsche Bank

Not all economies were born equal. Despite being in lockdown for the shortest amount of time, New Zealand has experienced the highest level of inflation in over a decade at 3.3%, breaking its inflation target much like the US and the UK.

However, countries like Japan continue to struggle with deflation. Japan has faced deflationary pressures for decades, with prices dropping 0.1% in May from the previous year. Though research suggests that these pressures are in part linked to declining import prices and a negative output gap, the $708bn covid stimulus package has done little to ease some of these pressures.

There are also those in the middle. The Eurozone inflation rate is such an example, as it was below target at 1.9% in 2021, though it is expected to increase in the second half of the year.

Truly transitory?

Through the resurgence of post-lockdown spending, we have seen increased demand for goods and services. This binge consumption, however, is likely to be short-lived, as consumers become reacquainted with post lockdown life.

Photo Of Woman Standing On Foot Bridge

Firstly, as consumers come out of lockdown, desire to travel has created upward pressure on areas like rental car prices. Supply chain disruptions have also pushed up secondhand car prices, as semiconductors, which are typically used in car production, have been incredibly hard to source.

This lack of new cars has made consumers shift to second-hand cars or rental car use. Therefore, rental car prices will likely return to normal levels as we slowly return to normal life, which hence highlights the argument that this inflation is only temporary.

Secondly, energy prices have sharply risen due to a jump in crude oil prices. Crude oil prices have tripled over the past year, and these costs therefore were passed through to the pumps, pushing up gas and electricity bills. As energy is an input factor for the economy, this will indirectly push up costs for other goods and services.

Standard chartered states that the month-by-month basis inflation for the month of June in the US was 0.9%. However, without accounting for rentals, energy and airfare prices, the underlying inflation would be just 0.22%. This clearly shows that the supply congestion and bottleneck factors that arise from the economy coming out of lockdown are driving high inflation in America.

It’s important to note that inflation reports on year-on-year changes in prices. So, saying that the US is experiencing 5.4% increases in prices compared to 2020, doesn’t necessarily mean as much as we may think.

For example, airfare tickets and energy prices were down significantly in 2020 due to low demand as a result of world-wide lockdowns. So, it’s only natural to see prices rise as we return to normal life and contextualise this inflation rate in comparison between prices in 2020, when the latter were significantly low, and those in 2021 which are gradually increasing.

The future of inflation

There could be less of a disparity in property prices in the long-term between cities and other areas such as towns. This could be due to changing preferences of the labour force which is opting to work from home.

White Architectural Baroque Building

Due to the pandemic, many people have been forced to work from home. This may mean that there is less demand for office spaces, and no longer the same requirement for employees to be available in a physical space. Many employees may also opt to continue to work remotely, as their physical presence may no longer be needed even once restrictions are removed.

Furthermore, they may also move from expensive cities to the places that are less expensive, dampening demand and therefore prices for properties in the city and increasing demand and prices for properties elsewhere.

This leads to land price equalisation, as more and more employees decide to work remotely. This is already a trend evident in the recent drop in London property prices. Hence, the digitalisation of work is a major deflationary pressure on city property prices.

In fact, this move out of the city, is likely to drive down prices of goods, education and healthcare – which are the factors that are the most inflation generating in OECD countries.

Moreover, the surge in inflation is heavily associated with the reopening of economies, supply chain congestion and higher energy prices. To an extent, we can claim this inflation to be transitory, and that it will subside as post-lockdown life progresses. Is inflation then just a clear sign of economic recovery in Western countries?

Perhaps we shouldn’t welcome inflation with open arms but we should recognise that in the short-term, higher inflation is a sign of economic recovery.

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