Beware the creeping inflationary threats
Central banks may find themselves forced to tighten their belts rather sooner than they anticipated
Dig deep enough, and you can always find signs of emerging inflation. My particular favourite right now is the price of Dutch and Spanish vine tomatoes in my local Turkish supermarket. Up a third over the past month, it is still cheaper than Waitrose, but that’s nonetheless quite a rise. The proprietor blames it not on seasonal factors, but Brexit red tape and lockdown.
Anecdotal evidence such as this can be misleading. Your experience of inflation depends on what you buy and where you buy it; some prices will be falling just as others are rising, cancelling each other out. In any case, the official Consumer Prices Index, based on a weighted average of people’s shopping habits and theoretically ironing out local variations, remains remarkably low, at just 0.8pc in December compared to a year earlier.
Yet it is not just imported fruit and veg. Lots of things seem to be getting more expensive. There are also plenty of other straws in the wind. Commodity prices have surged dramatically, and so have a number of other input costs, such as freight and container rates.
Given that these costs were falling in the early stages of the pandemic, we are almost bound to see some base effects creeping into the official rate of inflation from April onwards, when all other things being equal, the global inflation rate will tick sharply upwards.
All this makes an interesting backdrop to the Bank of England’s latest quarterly Monetary Policy Report, due to be published on Thursday alongside the minutes to this week’s Monetary Policy Committee meeting.
It’s the Bank’s job to worry about inflation, but broadly speaking its policymakers are part of the global consensus on these matters – that Covid has further reinforced long run deflationary forces that naturally press down on inflation. It is countering the disinflationary threats, not those of emerging inflation, that constitute the major challenge.
Few central bankers disagree, with rising structural unemployment once government support programmes are removed widely expected to press down on wages for long into the future.
I’m not so sure. Decades of tame inflation has lulled us into a false sense of security. As with the Maginot Line, the defences built by France in the 1930s against invasion from Germany, it may be that the threat comes from a different quarter.
No one knows what the post-Covid economy is going to look like. The permanent scarring widely anticipated is by no means a certainty. To the contrary, pent up demand, held back by lockdown, ought to ensure a significant bounce in activity, or even a mini-boom, once people are allowed to interact and spend normally again. Mass unemployment may not be as much of a given as generally believed.
For now, there are admittedly some major unknowns to factor in, most of which argue for recovery delayed. Vaccines were meant to offer salvation from a year of repeated lockdown, with the UK particularly well placed to benefit having cleverly managed to position itself well ahead of the pack in its inoculation programme. It was hoped that once all the over 50s are vaccinated, which ought to be by early spring, there would be a big fall off in hospitalisations and deaths, allowing most of the social distancing restrictions to be removed.
But doubts are creeping in; will the vaccines prove effective against new variants, and even if they are, is there not a danger that once restrictions are lifted the virus will return to inflict major damage among those who either refuse inoculation or for whom it offers little or no protection?
Far from an easing of lockdown, the political pressure is for tougher restrictions still, such as Labour’s demand that the borders be almost wholly sealed. Any number of epidemiologists are lining up to warn against removing restrictions too soon, and further that there may need to be another national lockdown next winter. From merely suppressing the disease, total elimination seems almost imperceptibly to have become the goal. That’s going to take a long time, if indeed it is possible at all.
Against such an array of uncertainties, it is hard for the Bank of England to know if it is coming or going. The strategy will therefore be to adopt a wait and see approach – no immediate introduction of the much debated negative interest rate, and no further recharging of the monetary cannon with another dollop of QE. The last £150bn tranche, announced in November, is in any case not due to be exhausted at the present rate of spend until the end of 2021.
Seemingly everyone, from the IMF to the OECD, recommends that national governments and their central banks keep their foot flat down on the fiscal and monetary accelerator. Inflation would be a nice problem to have, they seem to be saying.
They should be careful what they wish for. They may be getting it soon enough, such has been the explosive growth in global money supply over the past year, with burgeoning deficits widely financed by central bank money printing.
The question, perhaps, should not be whether the Bank is doing enough to support the economy but rather whether it has already done too much.
As a branch of economics, monetarism is deeply unfashionable these days, and certainly holds little or no sway among the world’s major central banks. But it could be that its time has once more arrived.
Tim Congdon, one of Britain’s leading monetarists, anticipates US inflation of 5.5pc by the end of the year, and doesn’t rule out a further surge into double digits further out. There is no sign of the let up in expansionary policies that might prevent these pressures.
Congdon may be an outlier, but he makes some entirely valid points. Unable to spend the surge in new money because of lockdown, it has instead found its way into asset prices. From the price of equities to houses, commodities, bitcoin, and yes, GameStop, they’ve all gone crazy since the March trough.
Once that inflation finds its way into the price of goods and services, you’ll pretty soon see wages chasing it upwards. That’s what happened in the 1970s, despite prices and income policies and rising unemployment. Who says it cannot happen again? Already we see acute skill shortages in the sectors for which Covid has been a positive boon.
Nothing is certain in economics, but central banks may find themselves forced to tighten rather sooner than they anticipate.
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