Is inflation dead?

Inflation has been suppressed in a number of developed countries for decades. Hence you often hear the claim that, at least in major economies, inflation is dead. But is that really true?

Yes, inflation rates across major markets are relatively low compared to historical levels, and in the near future, the impact of the coronavirus outbreak and the related shutdowns of large parts of these economies is likely to further push inflation levels lower.

Yes, this does mean that in the next months a widely expected economic downturn will put a cap on companies’ pricing power. This could be exacerbated by pricing struggles between businesses seeking to survive the weeks and months of no trading once any lockdown measures have been lifted and companies can return to competing for clients and customers. But does this mean inflation really is dead?

No is our answer.

Never-seen-before economic support packages

Consider this: many of the major economies’ governments have developed crisis responses at extents never seen before, which will inevitably end in enormous budget deficits. And these responses are supported by even bigger asset purchases by the central banks – and also those are larger than what we have ever seen before.

Similar, yet significantly smaller, asset purchases have in the past supported economies in recession. Not only did inflation increase during those episodes of quantitative easing (QE) but also inflation expectations were well supported, both consumer and market-based ones.

Still, QE and the large fiscal deficits needing financing are only two reasons why we see a rebound in inflation on the horizon in the medium term.

Globalisation – have we reached a peak?

Significant pressure on prices in the past decades was related to the influence of globalisation and low-cost countries’ exports to developed economies. This influence has kept inflation at moderate levels across most major markets. But already before the COVID-19 outbreak ever more protectionist tendencies have become evident. Be it in the US, which has started imposing trade tariffs on a growing number of countries and industries since Donald Trump took the presidency, or countries within Europe – also Brexit could certainly be counted as an example here.

These protectionist moves are only likely going to be exacerbated by the coronavirus crisis. Many developed countries have already faced difficulties importing healthcare supplies and suffered shortages, during the lockdown in important regions in China and east-Asia. This does increasingly raise questions over the role of globalisation and major economies’ degrees of dependency on foreign trade, especially in vital sectors.

A breakdown of supply chains of this kind is a major problem in an interconnected world. Comparing the COVID-19 crisis to 2011, the year the Fukushima nuclear reactor blew up, could give us an indication as to how supply chain disruptions across a number of industries might impact inflation. Following the disaster, which especially hit the automotive industry hard, US and EU inflation reached 3.2%1 and 3.3%2 respectively by the end of 2011. The levels jumped from 1.6% and 1.7% in 2010, according to consumer price inflation (CPI) data from the WorldBank.

Bearing this in mind, and the large impact on supply chains in 2020, we believe the risk of higher inflation is very real.

So, in our opinion, inflation is not dead. It might be dormant in 2020, but in the medium term, it will likely return to stronger levels than we have seen for decades.