Is the high inflation in the US and the euro zone permanent or just temporary? There are good arguments for both. The answer to the question should also be decisive for the further development of the stock exchanges.
Consumer prices in the USA and the euro zone have risen sharply.
The inflation rate in the USA rose to a whopping 7 percent in December – the highest level since autumn 1982. This weighs on the mood on the financial markets, which have been supplied with very cheap money for years. Speculations are circulating that the American Federal Reserve could raise interest rates faster than planned. For this year, the Fed has announced that it will reduce its bond purchases faster than expected, and three interest rate hikes are also expected.
However, the glut of money in recent years was undoubtedly an important reason for the bull market in share prices. If the central banks continue to take their foot off the gas pedal, share prices could increasingly lack impetus. Inflation data plays an important role in this – a crucial question is whether it will only be temporarily or permanently high.
There are good arguments for both scenarios, and two camps have emerged among economists and market observers. In financial jargon, these would be referred to as “Team Transitory” (temporary) and “Team Permanent”, it was said on Thursday at an event organized by the asset manager Swiss Life Asset Managers.
Hope for temporary inflation
The much larger camp is that of those who expect higher inflation only temporarily. This is also likely to be related to the fact that permanently higher inflation would be a much more uncomfortable scenario for market participants.
A major reason why inflation could start falling again soon would be an improvement in the broken supply chains in the production of goods and in global trade. According to Marc Brütsch, chief economist at Swiss Life Asset Managers, there are increasing signs that these bottlenecks will soon be resolved. Semiconductors would be produced in record numbers and new factories would be built in the US, EU and Japan. Microchip prices are already showing a downward trend, and production in the automotive industry is increasing.
Lars Kalbreier, global investment manager at Bank Edmond de Rothschild, also expects the disruptions in the supply chains to subside in the second half of the year. Brütsch puts it as follows: the supply side has entered a “pig cycle” in key areas, which will ensure lower rather than higher prices in the medium term. This suggests that inflation will soon come down. “The best remedy against high prices are often the high prices themselves,” says Brütsch.
According to him, the inflation rate in Germany, for example, is also due to special tax measures such as CO2-Taxation increased. These base effects would disappear this year, so the inflation rate in Germany should fall in the first quarter of this year.
Another important factor for declining inflation is that the tailwind of the ultra-expansive fiscal and monetary policy is slowly fading. This is considered an important factor for higher inflation. After last year’s lockdowns, demand for energy increased massively and simultaneously in different economies, supported by the same fiscal and monetary stimulus.
This contributed to the sharp rise in energy prices. According to Kalbreier, there could soon be some relaxation here. Energy prices were also driven up by one-off effects. These included the cold summer in Europe last year and the low level of energy production from wind turbines. The gas price was also pushed up by the conflict between Russia and Ukraine.
Arguments for permanently higher inflation
The fewer number of economists and observers who assume higher inflation rates in the long term, on the other hand, cite the danger of a wage-price spiral developing as an argument. Kalbreier sees such a development primarily for the USA. After all, it is a declared goal of the government under President Joe Biden to increase the wages of low earners.
According to Liechtenstein-based VP Bank, average hourly wages in the US have recently risen at rates of around 5 percent compared to the previous year. In addition, workers in the United States have not returned to their jobs in the past few months to the extent that might have been expected. The number of vacancies in the USA is already at a record high.
According to Brütsch, there is little reliable data available for the broad wage trend in 2021. In the US, labor cost growth accelerated in the third quarter of last year. In the meantime, no strong wage growth has been observed in Europe and Switzerland, says Kalbreier.
So-called “greenflation” also speaks in favor of higher inflation rates in the longer term. According to Brütsch, efforts to decarbonize the economy have “finally received a price tag” in 2021. Energy prices on the raw material markets have risen massively. However, the higher prices are no longer an incentive to increase the supply of fossil fuels. Finally, the additional emissions of CO2 with the purchase of emission papers, which have also become more expensive. As a result, the situation with the oil price is not easing. According to Swiss Life Asset Managers, energy prices contributed more than half to the high inflation rates in Europe by the end of 2021.
According to a recent paper by the major bank Credit Suisse, underinvestment in fossil fuels and the volatility of renewable energies are likely to lead to energy shortages. On its own, “greenflation” will probably not ensure persistently higher inflation, but it could lead to price fluctuations and uncertainties with regard to monetary policy.
Kalbreier assumes, however, that politicians will increasingly keep an eye on reality. The conviction that nuclear and natural gas technology are needed for the transformation to a decarbonized economy is becoming more and more widespread. The most recent announcement by the EU Commission should also be seen in this regard, according to which investments in nuclear or gas-fired power plants should be categorized as climate-friendly under certain conditions.
Differentiation between regions worldwide necessary
Overall, Kalbreier emphasizes that it cannot be said in general that inflation is coming back. Rather, one must differentiate by region. Higher inflation rates are still to be expected for the USA than for the euro zone and, above all, Switzerland.
Brütsch assumes that inflation in the euro zone of 5 percent will level off again close to the target value of the European Central Bank. This has been aiming for a symmetrical target of 2 percent since July. For Switzerland, Swiss Life Asset Managers expects an average annual inflation rate of 0.6 percent for the next five years. This sounds like little, but in the ten years before the pandemic the average annual inflation in Switzerland was only 0.2 percent. Credit Suisse has also revised its inflation forecast for Switzerland in 2022 from 0.5 to 1 percent.