Is inflation “dead”? This year’s “epic spending and borrowing binge” by governments, near-zero interest rates and record-high stock prices all suggest that everyone thinks big price rises are a thing of the past, says The Economist. But the coming year could bring a few inflationary surprises, say Reade Pickert and Vince Golle on Bloomberg. Prices of industrial metals such as copper and iron ore are already soaring. A vaccine will induce a rush for travel and leisure activities next year, which could trigger price rises in unexpected places.
Yet any inflation spike will be a temporary “mirage”. US unemployment was 6.7% in November, almost twice last year’s level. With so much slack in the labour market, workers have little scope to demand higher pay. If wages don’t rise then inflation will have a hard time taking off in the longer-term.
Inflation: this time is different
Some warn that central banks are sowing the seeds of future inflation, says The Economist. Similar worries about quantitative easing (QE) – buying bonds with printed money – after the 2008 financial crisis “ended up looking silly”: over the past decade, average annual inflation rates in developed countries remained “stubbornly below 2% a year”, a far cry from the 10% annual jumps seen in the 1970s.
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Yet this time around governments are more willing to spend, and central banks are happy to help them. Covid-19 has cost the UK Treasury £280bn this year and “as fast as the government is selling bonds, the Bank of England is buying them…with newly created money”, writes John Whittaker for Theconversation.com. UK public-sector net debt is over 100% of GDP.
Central banks’ credibility is on thin ice
The Bank of England insists that its willingness to print extra money just as the government needs it is a “happy coincidence”, says Jeremy Warner in The Daily Telegraph. It says the extra QE is needed to hit the inflation target. That argument might be just about plausible for now, but the real test will come if inflation spikes. Will the Bank then raise interest rates as per its mandate, even if that leaves the government nursing a potentially ruinous bill on all its new debt? “Rarely before has credibility been on such thin ice”. Other central banks have already eased their commitment to fighting inflation. The US Federal Reserve announced in August that it would become more tolerant of inflation going above the 2% target for short periods of time.
The current market consensus is optimistic; global “reflation” next year is expected to bring strong growth with low inflation, says Gavyn Davies in the Financial Times. That leaves stocks vulnerable if central bankers really are forced to hike interest rates at some point. During the inflationary 1970s a standard 60% stock and 40% bond portfolio lost 1.5% a year in real terms. Even investors who don’t think that inflation will stage a comeback this decade need to prepare, just in case they are wrong.
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