Inflation - transitory or the never-ending story?

Inflation is on the rise. The reasons are complex but the big question is, is it transitory or will it endure? How should governments, central banks and policy-makers generally respond?

Price surges have emerged in many corners of the globe and the multiplicity of potential causes has led to diverging views on the most likely trajectory. Responses vary on whether the greater risk in advanced economies is high demand, leading to overheating, or rapidly rising costs on the supply side, leading to stagflation (increasing prices with simultaneously slower growth – this is unlikely). Another point of contention is whether we are seeing a general rise in overall price levels or whether price pressures are contained within specific product markets.

The way in which governments and central banks deal with inflation will be pivotal.

According to leading economists, central banks reducing emergency stimulus (quantitative easing) too quickly and further supply chain disruption are among the top risks to the world economy in 2022 as the COVID-19 pandemic lingers.

Current inflation developments are driven by many overlapping factors. For now, pandemic-related causes still dominate but these should be largely transitory. The global supply chain issues have been more severe and longer-lasting than expected but ultimately most disruptions should resolve over time e.g. consider the recent situation at U.K. petrol stations.

Policy makers need to consider both possibilities though (transitory and more persistent inflation) as they take decisions in the coming months. This suggests acting with caution for now but with decisiveness when the true nature of the current inflation situation becomes clearer.

In the case of volatile and high energy prices, a successful energy transition depends on securing predictable and stable operating conditions for energy producers and consumers, allowing for affordable, reliable and a sustainable energy supply for years to come.

As economies re-open, increasing pressure on service industries that have recently been experiencing weak demand is likely to increase, adding new sources of upward pressure on price levels. This pressure will be strong, and as a result, rises in interest rates will follow.

So where do we see inflation for the future?

While inflation may turn out to be higher than expected in 2022 and 2023, the structural forces that have kept inflation low and stable worldwide since the mid-1990’s (high debt burdens and increasingly skewed income and wealth distributions) remain in place and may have even been exacerbated by the COVID-19 crisis. The surge in inflation over the next couple of years is therefore likely to give way to another period of low and stable inflation - energy transition notwithstanding.

Supply chains are now generally at or above levels prior to the pandemic but higher demands are fuelling the rise in inflation. Moving forward, it is too early to tell how long the current spike in inflation will last but demand is expected to become more balanced, with consumption shifting global growth significantly above trend and this could remain positive for a number of years, helped in part by longer-duration fiscal spending on infrastructure.

Although every effort has been made to ensure that the information provided in this article is accurate and correct, the information provided does not constitute any form of financial advice. We recommend that you take financial advice before making any financial decisions.