Inflation is not the bogeyman it is cracked up to be. Doomsters were caught off guard last week when the US consumer price index (CPI) recorded a lower-than-expected 0.3 per cent monthly gain in August, temporarily boosting bonds and denting stocks.
It could be a game changer, reducing pressure on the US Federal Reserve to cut short its emergency support for the US economy earlier than planned. Chances are we are closer to the peak in inflation than the markets may think.
After all, much of the acceleration in headline inflation recently has been due to a statistical sleight of hand, the consequence of what economists call base effects. That’s the distortion caused by year-on-year CPI comparisons between higher price rises this year, amplified by price falls last year when the world first succumbed to the Covid-19 crisis.
The worst point might have passed and, as the economy normalises and headline inflation eases, immediate pressure on central banks to batten down the hatches with higher interest rates should subside.
There is certainly no reason for the Fed to hit the panic button on rates. Cost-push inflation factors should ease as global supply-chain logjams free up and demand-pull inflation pressures remain subdued, while consumer and business activity seems relatively sub-par.
Shelves are nearly empty in the paper towel section of a Target store in northeast Denver, US, on August 24. Spot shortages are apparent in stores as the supply chain continues to struggle under the stress created by the coronavirus on the economy. Photo: AP
It’s going to take a long while before global economic activity gets back to full strength. In the meantime, benign output gaps, low-capacity utilisation rates and a return to rising productivity should help constrain rising price pressures and moderate headline inflation rates in the longer term.
The Fed knows full well the potential damage it could wreak on global economic confidence by rushing into tightening too soon. During the infamous taper tantrum in 2013 when the Fed began to remove monetary stimulus from the economy, the markets gave the move a resounding thumbs down, and nosedived.
The Fed’s inflation hackles may be raised, but it has seen much worse in the past. It is also well aware that deflationary undercurrents are still being felt from the 2008 financial crash, just as much as there will be spillover effects from the Covid-19 crisis, which will probably be felt for years to come.
The recent spike in US CPI inflation to a 13-year high in July, to 5.4 per cent, comes well below the 13.6 per cent post-war peak in June 1980. Four decades ago, the world was in the midst of a devastating oil-price shock, which needed a dramatic tightening in global monetary policy to stop wage and price inflation spiralling out of control.
In the wake of the Covid-19-related recession in 2020, the last thing the global economy needs is another short, sharp shock from higher interest rates.
The deflationary consequences of the 2008 crash and the policy mistakes made in its aftermath – when global policymakers went too far on balance sheet restructuring, debt deleveraging and fiscal austerity – still linger today.
The legacy has been sub-par economic growth and too-low inflation, especially in economies like Europe and Japan. Core inflation rates had been looking benign for years in the run-up to 2020 and a persistent worry for policymakers wishing to normalise interest rate levels back to pre-2008 levels.
The odds are that the recent surge in headline and core inflation rates is nothing other than a temporary blip. Once the pandemic passes, underlying disinflationary forces will begin to reassert themselves again.
China has been in a favourable position as the strong renminbi has helped to moderate some of the impact of higher global prices on the domestic economy. And despite some lofty price gains at China’s factory gates, running upwards of 9 per cent year on year since May, so far businesses seem reluctant to pass these higher costs on at the consumer level.
China’s CPI inflation rate, at 0.8 per cent in August, looks a relative success compared to hefty headline numbers seen in other major economies. The good news for Beijing is that it leaves plenty of room for manoeuvre on interest rates either way.
Pipeline inflation pressures will subside and there should be scope for easier monetary policy if the need arises to keep the economy on track for 5.5 per cent to 6 per cent growth in the medium term. China is already showing better signs of coming out of the pandemic relatively unscathed compared to the dark days of 2020.
Inflation may worry the bond bears, but it’s nothing more than a storm in a teacup.
David Brown is the chief executive of New View EconomicsInternet Explorer Channel Network