Monday, March 8th, 2021
Long list of ingredients
The inflation cocktail is now being mixed
The economy is slowly picking up speed. The end of the pandemic seems to be in sight. One consequence: inflation is likely to return soon.
With the prospect of an end to the pandemic, inflation is about to make a comeback. Although inflation is still relatively subdued on both sides of the Atlantic, this will soon change. Energy prices will increase across the board compared to the previous year, as the pandemic caused a drop in demand in spring 2020. There could also be a consumer frenzy after the crisis has subsided, as many consumers inevitably hold their money together in lockdown.
In the financial markets, this expectation has driven bond yields higher. The trend-setting government bonds from the USA and Germany were at times as high as they were last around a year ago. While several ECB bankers have signaled their willingness to counter an undesirable further increase in yields with increased bond purchases, US Federal Reserve Chairman Jerome Powell has so far failed to make similar statements. The development is not "disordered" and therefore does not require any intervention. His house is sticking to the previous course. "Powell lets the market be the market," sums up Neil Wilson, chief analyst of the online broker Markets.com. "However, the market is testing its steadfastness."
As the economy of the eurozone is likely to suffer from the effects of the pandemic for longer than the USA, the Fed will probably have to change course sooner than the European Central Bank. "The Fed is not to be envied," says Mark Dowding, chief investor at wealth manager Bluebay. If it sticks to its loose monetary policy for too long, even though inflation is rising and unemployment is falling, its credibility is in jeopardy.
The US Federal Reserve had already gambled away trust after the financial crisis. Central bank chief Ben Bernanke casually dropped the remark in a 2013 congressional hearing that the Fed could gradually scale back its asset purchases if the economic data persisted. The result was a tremor on the stock exchanges: the so-called "Taper Tantrum", a kind of angry reaction to the suggestion of a tighter monetary policy.
US rate hike as early as 2022?
With its cash injections, the Fed has helped ensure that Wall Street flourishes as if the pandemic had never happened. Thanks to the concentrated firepower of billion dollar corona state aid and the central bank's support program of $ 120 billion a month, the US could overtake China in growth in 2021.
"If US President Joe Biden's rocket ignites, the US economy can even overheat," warns the head of the Kiel Institute for the World Economy, Gabriel Felbermayr. In his view, such a massive economic stimulus program would not only trigger a boom in the US, but also fuel inflation overseas. "Because it would cause price increases on the world markets."
Meanwhile, economist Shannon Seery of the US bank Wells Fargo assumes that in the wake of the upswing in the US, up to 2.5 trillion dollars of savings accumulated during the crisis are waiting to be spent. Even if part of it could be used to pay off debts, the desire to consume could lead to increased demand driving up prices.
Against this background, some investors expect a first US interest rate hike as early as mid-2022 instead of towards the end of 2023, as the Fed has signaled so far. According to Wells Fargo, the US interest rate meeting on March 17th could well bring about a readjustment of the interest rate outlook. At 1.4 and 0.9 percent, respectively, inflation in the US and the euro zone is still far from the central banks' target of around two percent, but it is rising steadily.
Rainer Weyrauch, manager of Fürst Fugger Privatbank, believes that short-term inflation rates of around three percent are possible. However, he does not expect monetary policy to be tightened prematurely. "A wage-price spiral like the one in the 1980s is far away." In addition, because of the increased debt, no state can afford high interest rates anymore. Therefore, the central banks would certainly oppose this. "We remember: 'Whatever it takes …'." With these words, the then head of the ECB, Mario Draghi, succeeded in calming the bond markets in the summer of 2012 at the height of the euro debt crisis.
ECB in focus
The euro area is currently lagging behind the USA. The USA is clearly in the fast lane when it comes to growth prospects, vaccinations and also the development of inflation. A first indication of how the euro central bank assesses the situation should be provided by the new economic projections of the ECB economists at the interest rate meeting on Thursday. Inflation in the currency area had recently risen again. And many experts assume that the upward trend will stop for the time being, should the pandemic be gradually brought under control. Rates of 1.9 percent inflation in the fourth quarter are considered realistic. By the end of 2021, the rate should even reach at least 2.5 percent, predicts chief economist Alexander Krüger from Bankhaus Lampe.
"This upturn in inflation this year continues to be largely driven by temporary factors," said Anatoly Annenkov, Societe Generale economist. "And the ECB, like us, will be preoccupied with the medium-term effects of the pandemic on the labor market and subdued wage growth." According to experts, the pressure for a tighter monetary policy will initially be greater for the Fed than for the ECB.
It is therefore no wonder that, according to a Reuters survey, economists do not expect a move away from zero interest rates until at least the middle of next year. The latest remarks by ECB boss Christine Lagarde also indicate that the monetary authorities will keep their money locks wide open – also to curb the recent rise in yields. Anyone who is betting on a change in monetary policy must therefore first look across the Atlantic.
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