Experts fear economic rebound will fuel inflation
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With a sudden upturn in the year-on-year inflation figures for April, to 4.4% from 3.2% in March, should we be worried that, after many years of relatively low inflation, it will shoot up into territory above the SA Reserve Bank’s 3-6% target range, with severe effects on consumers?
Between 1975 and 1993, inflation in South Africa remained well above 10%, peaking at over 20% in the mid-80s. After 1994, the Reserve Bank introduced its policy of inflation targeting, and things were slowly brought under control. There were two peaks of above 10% in the 2000s, but since 2010 inflation has remained pretty much within the target range, averaging about 4% in recent years
In the United States, inflation soared to about 15% in 1980, but has been low since then, averaging about 3%, and going lower to about 2% in the years since the 2008 financial crisis. In April, it suddenly soared to 4.2%, from 2.6% in March. This is the closest the US and South African inflation figures have been in decades.
Inflation in the Euro zone has been even lower. Since the 2008 crisis it has hovered around 1%, frequently dipping into negative territory. It too has picked up, to 1.6% in April, after spending the last four months of 2020 below zero.
In an article published in the 1st-quarter 2021 edition of Personal Finance magazine, “Inflation: coming to an economy near you?”, Sahil Mahtani, a strategist at the Ninety One Investment Institute, and Russell Silberston, a portfolio manager at Ninety One, suggest that the coronavirus may have ushered in a more inflationary environment globally. They say financial experts were puzzled when government stimulus in 2008/9 did not trigger inflation (instead it appeared to have the opposite effect), and are now assuming that the massive financial stimulus to help economies recover from the pandemic will have the same benign outcome.
“That inflation has been subdued in the decade since [the financial crisis] partly explains why many investors seem sanguine about the inflation outlook now. We hesitate to write these words, but this time it could be different: we see a significantly higher risk of inflation in the next 10 years than in the last 10,” Mahtani and Silberston say.
- The possibility governments will let inflation rise to “inflate their way” out of debt.
- An increase in conflict and competition among nations, in contrast to the generally co-operative environment following the 2008 crisis.
- Some deflationary forces that the world has enjoyed in the recent past may have waned: there has been a retreat from globalisation, which has held prices down, and deflationary demographic trends – specifically, rising life expectancy and falling birth rates – may have peaked.
Taking a shorter-term view in a recent newsletter, Old Mutual Wealth investment strategists Izak Odendaal and Dave Mohr say inflation is very much in focus globally. “Investors are nervous that sharply higher inflation will put pressure on central banks to raise interest rates, potentially knocking the global economy and short-circuiting equity markets,” they say.
They expect the Federal Reserve in the US to err on the side of caution in raising interest rates in response to higher inflation while recognising the need to ease back on monetary stimulus measures as the US economy rebounds.
“The most likely path of global inflation is still, in our view, that it will moderate going into next year,” Odendaal and Mohr say. “First, the base effects (the rebound off a low base) will fade. Second, the big reopening boom is likely to be fairly short-lived. Third, supply will eventually respond: if there is massive demand for something anywhere, firms have every incentive to meet that demand as soon as possible. Finally, technology remains a disinflationary force. And while it may be too soon to tell if it is the start of a trend, productivity growth seems to be making a comeback. Productivity growth means firms can absorb higher input costs without it leading to higher inflation.”
Graham Wainer, chief executive and head of investments at Stonehage Fleming Investment Management in the UK, also worries that an economic rebound will trigger higher inflation globally. “Could the combination of resurgent consumer spending and highly expansive policy lead to overheating economies, fuelling persistently higher inflation, which in turn would force central bankers to raise interest rates?”
Wainer believes higher inflation in the near term is inevitable. The critical question, he says, is whether rising inflation will become a sustained trend, leading to a tightening in monetary policy and an end of the recovery.
“In our view, there is little evidence of this scenario playing out before the middle of this decade. We do not expect uncontrollable inflationary pressures to derail the recovery in the short term, and observed inflation rises will be driven primarily by ‘base effects’ and the recovery of energy prices. However, the longer-term balance of risk has shifted. Post-crisis policy is firmly in expansionary territory and, unlike in the years that followed the 2008 financial crisis, is not expected to pivot towards austerity anytime soon,” Wainer says.
The South African Reserve Bank’s policy of inflation targeting involves raising interest rates when inflation rises. But while acknowledging an increased inflation risk, the Reserve Bank did not raise interest rates at its most recent monetary policy committee (MPC) meeting. However, all indications are that we have reached the bottom point in the interest rate cycle, and that rates will rise gradually from next year.
Odendaal and Mohr say the MPC noted that the relatively strong exchange rate would counter global price increases, while a lack of pricing power on the part of firms and lack of bargaining power on the part of unions will contain the inflationary pressures stemming from food prices and electricity tariffs. However, the MPC also noted that its forecasts are more likely to underestimate than overestimate inflation.
Although advantageous for consumers with debt or home loans, low interest rates are detrimental for savers and pensioners living off the proceeds of their savings. If interest rates remain low while inflation rises, which has just happened, it’s a double-whammy for them.