Transitory inflation talk is back. But economists say higher prices here to stay
Fruit and vegetable racks are displayed in a store in Brooklyn, New York City, March 29, 2022.
Andrew Kelly | Reuters
Global markets have taken notice in recent weeks from data suggesting inflation may have peaked, but economists warn against a return to a “temporary” inflation narrative.
Stocks bounced as the October US consumer price index fell short of expectations earlier this month, as investors began betting on easing the Federal Reserve’s aggressive interest rate hikes. .
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While most economists expect the overall rate of inflation to fall significantly in 2023, many doubt that this will herald a downward trend in core inflation.
Paul Hollingsworth, chief Europe economist at BNP Paribas, warned investors on Monday to beware the return of “Team Transitory”, referring to the school of thought that the expected inflation rate The increase at the beginning of the year will be fleeting.
The Fed itself is a supporter of this view, and Chairman Jerome Powell ultimately issued a small apology accepting that the central bank had misunderstood the situation.
“Reviving the ‘temporary’ inflation narrative looks appealing, but core inflation is likely to remain elevated by past standards,” Hollingsworth said in a research note. said in a research note, adding that the risk of a rate hike next year remains, including the possibility of a recovery in China.
“The large swings in inflation highlight one of the key features of the global regime change we believe is underway: more volatile inflation,” he added.
The Bank of France expects a “historically large” drop in headline inflation next year, with most regions experiencing lower inflation than in 2022, reflecting a combination of of the underlying effects—the negative contribution to the annual inflation rate that occurs when the monthly change shrinks—and the change in the dynamics between supply and demand.
This could revive the narrative “temporarily” next year, Hollingsworth notes, or at least risks investors “extrapolating inflation trends emerging next year as an indication for see inflation rapidly returning to its ‘old’ normal.”
These narratives could translate into official projections from governments and central banks, he suggests, with the UK’s Office for Budget Responsibility (OBR) forecasting full deflation by 2025- 26 “in sharp contrast to current market RPI fixes” and the Bank of England forecasts medium-term inflation to be significantly below target.
Skepticism about a return to normal inflation was echoed by Deutsche Bank. Chief investment officer Christian Nolting told CNBC last week that the market valuation for central bank cuts in the second half of 2023 is premature.
“When we look at our models, we think yes, there’s a slight recession, but from an inflationary standpoint,” we think there are second-round effects, Nolting said.
He points to the seventies as a comparable period when the Western world was rocked by an energy crisis, suggesting that the second-round effects of inflation had arisen and central banks “cutting too soon”.
“So in our view, we think inflation will be lower next year, but also higher than in previous years, so we will stay at a higher level, and from a That being said, I think the central banks will stay the same and not cut much.” fast,” added Nolting.
Reasons to be cautious
Some of the significant price spikes during the Covid-19 pandemic are seen by many as not actually “inflation”, but rather the result of relative shifts that reflect specific supply and demand imbalances, and the BNP Paribas believes the same is true in the opposite case.
Therefore, deflation or outright deflation in some sectors of the economy should not be taken as an indicator of a return to the old inflationary regime, Hollingsworth urged.
Furthermore, he suggested that companies may be slower to adjust prices down than to raise prices, given the effect of rising costs on profits over the past 18 months.
While commodity inflation is likely to slow, BNP Paribas sees service inflation being more difficult in part due to underlying wage pressures.
“The labor market is historically tight and – to the extent that there may be a structural element to this, particularly in the UK and US (e.g. an increase in inactivity due to long-term illness) UK term) – we expect wages to grow at a relatively high rate by previous standards,” said Hollingsworth.
China’s Covid policy has taken back headlines in recent days, and stocks in Hong Kong and the mainland rebounded on Tuesday after Chinese health authorities reported vaccination rates for people. There has been a recent increase in the elderly, seen by experts as crucial to reopening the economy.
BNP Paribas predicts that the gradual easing of China’s Covid-free policy could be inflationary for the rest of the world, as China has contributed little to global supply constraints in recent months. recent and the easing of restrictions “is unlikely to boost supply significantly.”
“Conversely, a stronger recovery in Chinese demand is likely to put pressure on global demand (especially for commodities) and therefore all other factors creating pressure,” Hollingsworth said. inflationary pressure”.
Another contribution, he added, is the acceleration and highlighting of decarbonization and de-globalization trends caused by the war in Ukraine, as both are likely to increase inflationary pressures in the medium term. .
The BNP asserts that the change in the inflation mechanism is not just where rising prices will stabilize, but rather volatility in inflation that will be punctuated by large swings over the next one to two years.
“Admittedly we think volatility in inflation is still likely to decline from its current extremely high levels. However, we do not expect it to return to levels that characterize ‘moderation’. wonderful’,” said Hollingsworth.