Fear, or at least concern, is sweeping the financial markets. Are the current rising prices having a negative impact on growth? Will interest rates rise and strangle the economic recovery? According to the textbooks of national economics, this would be the logical consequence. If it weren’t for the many pandemic-related special factors. Times are anything but normal at the moment, the situation is still unclear. Monetary policy is likely to remain loose until 2022.

 

Exaggerated fear of inflation

BAK Economics, the politically and scientifically independent Basel Working Group for Business Cycle Research (BAK) considers “fears of rampant inflation” to be “exaggerated, at least in the short term and especially for Switzerland”. For the Basel economists, the main cause of the current price increases is that global demand – which slumped due to the pandemic – has picked up again strongly. The current upward price movements are an expression of normalisation.

The “forced saving” caused by the pandemic has held back purchasing power, which is now unfolding all the more strongly. This is particularly evident in the luxury goods sector, for example. Worldwide, spending on luxury watches, jewellery, fashion and accessories is rising at an above-average rate. In the high-end watch price segment, delivery times are sometimes months long. Bucherer in Zurich, for example, vaguely states the delivery time for a Rolex men’s wristwatch in stainless steel and white gold (Datejust model, price just under CHF 10 000) on the phone as “several months”.

 

Surprised by the speed

Many producers were surprised by the pace of the global recovery. The business climate improved significantly not only in the USA, but also in Europe. The economic barometer, which the Swiss Economic Institute (KoF) of the ETH Zurich uses monthly to measure the general mood of the Swiss economy, continues to point upwards and reached a historically high 143.2 points in May, an increase of 6.8 points compared to April. Only a year ago it had reached a pandemic low of 51.64. The recent sharp rise is attributed by the KoF to a “bundle of indicators” from different sectors (manufacturing, foreign demand, hotels and restaurants, other services).

Consumption is strong again. DIY stores, for example, are not yet able to meet the revived demand for home improvement after the easing measures. Due to the pandemic, producers of goods and services for daily use are not yet allowed to offer as many products as they could. The restrictions are only now slowly being withdrawn in the wake of the success of the vaccination. However, there were also restrictions in the global supply chain due to accidents that had nothing to do with the pandemic. A container ship that ran aground blocked the Suez Canal for days, high-performance computer chips for high-tech products became even scarcer due to a major fire in a chip factory, and renewed corona-related closures of ports in China restricted the supply chain and caused container prices to rise up to threefold.

However, inflation only becomes dangerous for economic development when inflation expectations also shift significantly upwards, i.e. when “a self-reinforcing price-wage spiral” (BAK Economics) is set in motion, which can only be reversed by the central banks tightening monetary policy (i.e. abandoning the zero interest rate policy and raising key interest rates). This hurts, dampens growth prospects and the willingness to invest. On the stock exchange, prices fell.

The general excess demand is currently leading to significantly higher inflation rates in some countries. However, much of this is temporary and will not be enough to “drive inflation expectations to a level that is no longer compatible with price stability”, BAK Economics reassures. This is because “deflationary counterforces” are still very important. For example, despite the recovery, the global economy is only slowly returning to normal capacity utilisation, unemployment is still higher than before the pandemic and the still intense global competition is keeping prices in check.

 

Inflation expectations put to the test

In the medium and long term, however, inflation could show its claws. The pandemic has “improved” the conditions for this. Thus, the already high public debts have risen sharply again worldwide. Liquidity at zero cost tempts people to go into debt. Many countries, it seems, have become more inflation-tolerant. Inflation expectations, which are still firmly anchored, could be subjected to a serious test in the coming years, especially in the USA and the Eurozone. This scenario would also be uncomfortable for Switzerland. Although the risk of inflation remains low in this country, an inflation-related slump in demand in other countries and an appreciating franc also pose a serious threat to the Swiss economy, warns BAK Economics.

Inflation is more advanced in the US than in Europe. There, consumer prices rose by 5% year-on-year in May, compared to 4.2% in April. At 0.6%, the month-on-month increase was stronger than forecast (0.4%). The increase in the core inflation rate (excluding food and energy prices) was 3.8% year-on-year in May and 0.7% compared to April. However, the year-on-year comparison is distorted due to the pandemic. This base effect keeps concerns in check for now. “The latest data points on the development of the consumer price index and the inflation expectations of the population do not yet indicate that a dangerous dynamic is already underway,” the NZZ notes. The situation is simply still too unclear, too many special effects are at play. Compared to the USA, the inflationary push in Switzerland is still harmless. Consumer prices, which have been stagnating for years, rose by 0.3% in May compared to April. According to the Federal Statistical Office (FSO), the national consumer price index (CPI) reached 101.0 points (December 2020 = 100). Compared to May 2020, inflation was 0.6%. In Germany, consumer prices rose by 2.5% year-on-year in May – the fastest pace in almost ten years. In the second half of the year, it could be up to 4%, Aquila AG expects.

 

Mostly only temporary effects

According to economists, inflation in Germany could rise to well over 3% in the course of the year. “However, temporary effects (such as the temporary reduction in VAT in 2020) are largely responsible for this”, so that “noticeably lower rates can be expected again in 2022”, argues Marco Wagner, chief economist at Commerzbank. His colleague Jörg Zeuner from the fund provider Union Investment advises not to “overinterpret the monthly water level reports”. For Thomas Gitzel, chief economist at VP Bank, the “spook” (of rising consumer prices) will be over next year. “Germany, but also the Eurozone (…) will have to struggle with inflation rates that are too low rather than too high in the longer term,” Gitzel predicts. The European Central Bank (ECB) also knows this. The German ECB Executive Board member Isabel Schnabel had already stressed in mid-May that the ECB was looking “through all these short-term fluctuations”. After all, its monetary policy is geared to the medium term. For 2021 as a whole, the ECB still expects 1.5% inflation. New forecasts are expected this month.

The US Federal Reserve (Fed) tirelessly emphasises the temporary nature of the rise in inflation. This cannot be transmitted linearly into the future. The basic statistical data signal that longer-term inflation expectations in the USA will currently be above the 2% traditionally set by the Fed, but not by too much. For the time being, confidence still prevails in the markets that the US monetary authorities can keep price developments under control. The largely COVID-induced surge in inflation should therefore subside again after the pandemic.

 

It’s already in the Fed minutes

Not everyone sees it that way. The editors of The Market quoteTadRivelle, Chief Investment Officer of the US fund company TCW, who fears that rising prices for goods and services will not remain a temporary phenomenon. He sees a risk that investors will gradually lose confidence in the dollar.

So far, investors have been able to rely on the Fed’s quantitativeeasing (QE) programme to provide ample and cheap liquidity through purchases of securities/bonds. Now there are first indications that it might soon steer a less expansionary course and that the famous tapering, i.e. the slow reduction of quantitative easing, will be back on the agenda. On page 10 of the minutes of the most recent meeting of the Fed’s Federal Open Market Committee(FOMC), which is responsible for monetary policy, published on 19 May 2021, it reads as follows: “A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases”. So the discussion has begun in the FOMC about whether, when and to what extent the bond purchases could be reduced.

 

BoC forges ahead

The Bank of Canada (BoC) has already made facts and announced at the end of April that it would reduce its monthly bond purchases by a quarter. In response to the BoC’s announcement, the Canadian dollar rose sharply and the yield spreads of Canadian bonds over US Treasuries widened. Preparing markets for the inevitable tapering without spreading panic requires communicative finesse. “One wrong word and the fear from 2013 could return,” warns Union Investment. Back then, Fed Chairman Ben Bernanke had sent the global financial markets into a panic with unclear statements on the expiry of the tapering of bond purchases. Bond prices plummeted abruptly, including in emerging markets. “The central banks are likely to want to avoid a repeat of this at all costs,” says Union Investment.

Because with the reduction of bond purchases, the first interest rate hike is not far away. The markets are probably already preparing for this turnaround. The central banks are still managing to calm the markets. Global monetary policy could therefore remain loose for a while – probably until 2022.


Manred Kröller
Financial journalist

 

 

This post has been translated automatically

 

 

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