Global inflation is more than temporary

The supply chain disruptions have pushed up global inflation. 

For instance, if you look at the FOMC’s forecasts, “temporary” seems to be no more than a year but Mr. Steve Barrow, Head of Standard Bank G10 Strategy suspected that “temporary” would last much longer, both in the US and elsewhere.

Central banks almost predict that the inflation rate will return to the target over whatever period they forecast. By definition, this has to be the case because otherwise the stance of monetary policy would be wrong and it would have had to be changed when the forecasts were made. Hence, when we’ve seen periods of very low inflation central banks have usually forecast a return to target, or near target over a 2- 3 year horizon (which is what most of them use). Right now, inflation is starting to overshoot on the upside in countries such as the US and UK, but central banks not only predict a return to target; they anticipate a very quick return.

In the US, for example, core PCE inflation is currently running at a 3.6% annual pace but the last FOMC forecasts predict that this will be down to an average rate of 2.1% next year. New forecasts are due next week and it would not be surprised if the forecast is lifted slightly but, Mr. Steve Barrow said that it would still suggest a pretty rapid unwind of the price pressures that he is seeing right now. It is a similar story if we look at the Bank of England’s forecasts for the CPI as well. Annual CPI inflation could reach over 4% this year but the Bank predicts it will be back under the 2% target over its three-year forecasting horizon.

Despite this optimism, there seem to be increasing signs that the factors that are lifting prices and wages are more persistent than expected. These include supply-chain tensions and the reticence or inability of many of those unemployed to re-enter the labour force. We can see this reflected in many prices lower down the supply chain. Commodity prices have not retraced their sharp rise over the past year, or so. The CRB index, for instance has merely plateaued at an annual gain of near 40%. Tanker rates remain sky-high and producer prices continue to rise sharply, up 11.4% at an annual rate across OECD countries in July. PMI surveys continue to show very elevated readings when it comes to prices with no obvious sign that the strains are easing.

In addition, firms are reporting it is increasingly hard to find the workers they want, with wages rising as a result. “At a minimum, these sorts of factors suggest to us that price pressures will remain sufficiently elevated to invalidate central bank expectations of a quick return to target. At a maximum it seems conceivable that supply chain stresses could continue for some time, worker reticence remain and the rise in measured inflation become embedded in expectations. If we think about some of the factors that have created pressures, such as the semiconductor shortage or Brexit ‘teething problems’ in the UK, it is fair to say that they have persisted for longer than many – including policymakers – anticipated. If this proves to be the case for other supply chain disturbances as well, we would not just expect inflation miss the 2% central bank targets by a wide margin next year but probably in future years as well. Of course, the Fed does have an average inflation target now and not a point target. But it is hard to believe that FOMC members would see 3 years, or more, of significant inflation overshoots as being consistent with an average 2% target”, Mr. Steve Barrow forecasted.

Will central banks such as the Fed and BoE lift rates quickly if inflation proves to be more stubborn than anticipated? Mr. Steve Barrow doubts it. As long as supply-chain/labour shortages seem to be the reason for elevated prices the banks are likely to show patience. But the market might not and that could mean steeper yield curves.