Is the global inflation rebalancing?

We’ve seen a degree of rebalancing in inflation, with goods and services inflation picking up relative to the inflation we have seen in asset prices.

Whichever way you cut it there’s been a substantial increase in global liquidity that really started around 2000 as central banks accumulated vast FX reserves which inevitably leaked through to lift monetary growth. Subsequent crises, such as the global financial crisis and Covid compounded the rise in liquidity to a point now where the major central banks such as the Fed and ECB are reporting substantial excess liquidity positions in the banking system. And yet, for all this rise in liquidity, inflation has been subdued. The rise in the supply of money should have lowered its price – which is inflation. Some argue that a fall in the rate of monetary turnover – velocity – has stopped this from happening.

“Any increases in demand, and hence potential inflation, resulting from fast liquidity growth, has been matched by booming supply, not least from China. Without any significant demand/supply mismatch, the prices of goods and services have stayed modest – up until very recently. But while the supply of goods and services has proved very elastic (again until recently), the supply of assets like stocks and bonds has been inelastic and, of course, central banks have cut back this supply significantly by hoovering up bonds as part of their quantitative easing programmes. The result has been that all the inflation has been in asset prices, not goods and services prices”, Mr. Steve Barrow, Head of Standard Bank G10 Strategy said.

As mentioned, some of these things have started to change recently. The supply of goods and services has been hindered by the supply-chain tensions coming from the pandemic and possibly also from reduced labour supply as workers reassess their options. Hence, we’ve seen a degree of rebalancing in inflation, with goods and services inflation picking up relative to the inflation we have seen in asset prices. An interesting question now is whether this is a temporary phenomenon or indicative of a significant shift that will last well into the future.

With ageing societies, particularly in developed nations, there is undoubtedly a greater threat that supply will fall short of demand and so lift prices. Climate change could exacerbate these strains as could the slowdown that we appear to have seen in globalisation as trade wars erupt, migration slows and re-shoring gains momentum. Policymakers too seem to be playing a part as many try to rectify the fact that the rewards to labour have slipped badly behind the rewards to asset investment. Tax hikes on the wealthy in the US and as proposed in Germany’s upcoming election are one example. The momentum for corporate tax cuts is being reversed as well, especially in countries such as the US and UK. “We can add to this the rise of more populist parties, often left leaning, in many countries putting a greater emphasis on the rewards to workers, not the holders of financial assets, and even real assets in the case of housing”, Mr. Steve Barrow stressed.

In sum, it does look as if there is some inflation rebalancing going on. This could occur at a slow and almost imperceptible pace as longer-term trends such as demographics, globalisation and taxation conspire to lift the share of wealth going to workers. Alternatively, it could happen in a far more dramatic way. For if goods and services inflation continues to soar unabated it would force central banks to act aggressively; something that would almost certainly cut inflation in riskier assets to the bone in one fell swoop. Clearly holders of such assets will be hoping that this does not happen. But even if their prayers are answered it looks as if some rebalancing of inflation will occur over the longer term even if it is modest and slow-moving.