The non permanent inflation speak is again. However economists say increased costs are right here to remain
Fruit and vegetable prices on display at a store in Brooklyn, New York City on March 29, 2022.
Andrew Kelly | Reuters
Global markets have been heartened in recent weeks by data suggesting inflation may have peaked, but economists are warning of the return of the ‘temporary’ inflation narrative.
Stocks rallied earlier this month as the US October CPI fell below expectations as investors began betting on an easing of aggressive US Federal Reserve rate hikes.
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While most economists expect a significant across-the-board decline in headline inflation rates in 2023, many doubt this will herald a fundamental disinflationary trend.
Paul Hollingsworth, chief economist for Europe at BNP Paribas, warned investors on Monday to be wary of the return of “Team Transitory,” a nod to the school of thought that projected rising inflation rates earlier in the year would be fleeting.
The Fed itself was a proponent of this view, and Chairman Jerome Powell eventually issued a mea culpa, accepting that the central bank had misjudged the situation.
“Reviving the ‘temporary’ inflation narrative may seem enticing, but underlying inflation is likely to remain elevated relative to previous standards,” Hollingsworth said in a research note, adding that upside risks to the headline rate next year remain , including a possible recovery in China.
“Wide swings in inflation underscore one of the key features of the global regime change we believe is underway: greater volatility in inflation,” he added.
The French bank expects a “historically large” drop in headline inflation rates next year, with almost all regions set to register lower inflation than 2022, reflecting a combination of base effects – the negative contribution to the annual inflation rate that occurs as monthly changes shrink – and the dynamics between shifts in supply and demand.
Hollingsworth noted that this could revive the “temporary” narrative next year, or at least risk investors “extrapolating the inflationary trends emerging over the next year as a sign that inflation is rapidly returning to the ‘old’ normal.”
Those narratives could be translated into official forecasts from governments and central banks, he suggested, with the UK’s Office for Budget Responsibility (OBR) forecasting outright deflation for 2025-26, “in striking contrast to current market RPI fixings.” and the Bank of England forecasts medium-term inflation to be well below target.
Skepticism about a return to normal levels of inflation was echoed by Deutsche Bank. Chief Investment Officer Christian Nolting told CNBC last week that pricing the market for central bank cuts in the second half of 2023 is premature.
“Looking through our models, we think, yes, there’s a slight recession, but from an inflation perspective, ‘we think there’s second-round effects,'” Nolting said.
He pointed to the 1970s as a comparable time when the western world was rocked by an energy crisis, suggesting that there were second-round effects of inflation and central banks were “cutting too soon”.
“So from our perspective we expect inflation next year to be lower but also higher than previous years so we will stay at higher levels and from that perspective I think central banks stay and don’t cut very quickly,” added Nolting.
Reasons for caution
Some significant price increases during the Covid-19 pandemic have not been widely viewed as “inflation” but as the result of relative shifts reflecting specific supply and demand imbalances, and BNP Paribas believes the reverse is also true.
Therefore, disinflation or outright deflation in some areas of the economy should not be taken as indicators of a return to the old inflationary regime, Hollingsworth urged.
He also suggested that given the impact of rising costs on margins over the past 18 months, companies may be slower to adjust prices down than to increase them.
Although goods inflation is likely to slow, BNP Paribas sees services inflation as more stubborn, partly due to underlying wage pressures.
“Labour markets are historically tight and – where there is likely a structural element to this, particularly in the UK and US (e.g. the rise in inactivity due to long-term illness in the UK) – we expect wage growth to remain relatively high compared to previous measures ‘ Hollingsworth said.
China’s Covid policies have made headlines again in recent days, and Hong Kong and mainland stocks rallied on Tuesday after Chinese health officials reported a recent surge in vaccination rates among seniors, which experts have said will be crucial to the country’s reopening economy is considered.
BNP Paribas believes that a gradual easing of China’s zero-Covid policy could be inflationary for the rest of the world, as China has contributed little to global supply constraints in recent months and an easing of restrictions “is unlikely to affect supply significantly.” will increase”.
“By contrast, a stronger recovery in Chinese demand is likely to put upward pressure on global demand (particularly for commodities) and thus, all else being equal, fuel inflationary pressures,” Hollingsworth said.
Another contribution is the acceleration and emphasis on decarbonization and deglobalization trends caused by the war in Ukraine, he added, as both are likely to increase medium-term inflationary pressures.
BNP claims that shifting the inflation regime is not just about where price increases are reflected, but also about the volatility of inflation, which is accentuated by large swings over the next year or two.
“Admittedly, we think inflation volatility is still likely to come down from its currently extremely high levels. However, we don’t expect it to return to the kind of levels that marked ‘grand moderation,'” Hollingsworth said.