Market Musings 06/11/21:
Challenging the Inflation Groupthink
Recent podcasts you may care to listen to:
Why the Central Banks have a tough job today
I actually feel rather sorry for central bankers these days. Yes of course, they are still very well paid for what they do, and in the US at least, have been engaging in dubious stock market investment practices.
From 2000 until the end of 2019, central bankers had a fairly easy job on their hands, with core inflation averaging 2% in the US (bang on the Fed’s 2% target), 1.4% in the Eurozone (well below the ECB’s target) and 1.6% in the UK (below the Bank of England’s target).
Well-marshalled core inflation from 2000 to 2020
Source: St Louis Fed FRED database
But since late-2020, central bankers have had an increasingly difficult job on their hands. A year ago, it was abundantly clear that central banks had to join governments in supporting the global economy in the wake of the sudden halt in many areas of economic activity due to COVID-19 and lockdowns.
But over one year on, with lockdowns behind us and the majority of economies reopened, and with the evident resurgence of prices in a whole host of goods and services, central banks have a much harder road ahead of them balancing economic growth with controlling inflation.
Headline inflation has leapt in 2021
Source: St Louis Fed FRED database
Let’s start with the obvious facts:
- Inflation rates are well above central bank targets (c. 2%) in the major developed economies, notably in the US and UK but also in Canada and Australia;
- Central banks in a number of countries (notably in emerging markets) have already raised their interest rates in response to higher inflation;
- Bond markets are not convinced at all by the ongoing mantra repeated by the US Federal Reserve and the European Central Bank, that the current bout of higher inflation rates is due to the after-effects of the pandemic is thus transitory, rather than a more permanent effect;
- Wages have been rising at faster rates, predominantly in low-pay industries like restaurants, hotels and retail, and particularly in the US;
- Inflation is also being pushed higher at the headline level by much higher energy and food prices.
