Divergence of price
Market pricing suggest that inflation is low on the list of investor concerns and this is consistent with the present recession and the prospect of a lacklustre recovery at best. Nonetheless, a few observers are questioning whether inflation could surprise on the upside, and not least given the large amounts of fiscal and monetary stimulus being pumped into the economy.
Michala Marcussen, Group Chief Economist and Head of Economic and Sector Research
While stimulus driven inflation is not impossible, we view this more of a tail risk, and not least given still powerful deflationary forces stemming from crisis impaired balance sheets. Digging into the inflation debate, however, we do see a case for divergence of price trends, be it across products and services, or even countries.
Bring up inflation, and the 1970s oil price shocks often spring to mind. In the present crisis, lacklustre demand and excess supply, have pushed prices down and even briefly into negative territory. Demand should pick-up as Covid-19 containment measures are lifted, but for some of the more energy intensive sectors, such as air travel, recovery is likely to be slow.
Conversely, prices for air cargo, presently in short supply with the grounding of many passenger flights, has shot up; ordinarily, lower oil prices would support lower cargo prices. More broadly speaking, disruptions are giving rise to numerous price shifts along the supply chain. Many fresh food prices, for example, have increased for retail consumers, while farmers struggle to get produce to market and are left holding excess. Some of these price shifts could linger into recovery, and potentially beyond depending on how producers adapt, consumer preferences shift, and government policies evolve.
Returning to energy, change may indeed be underway. Several producers have already announced fossil fuel capex cuts and plans to advance on emission reduction. Timing seems opportune with governments exploring new green deals, supporting investment into renewables and energy efficiency. Moreover, the rescue of some national airline carriers has come with the condition of cutting domestic routes where greener high-speed train travel is available. Again, durable relative price shifts seem likely.
One concern in the current environment is the strong domestic focus of government policies and in some cases, outright protectionism. This presents a global challenge, and not least for those emerging economies, where foreign direct investment has been a key growth driver. One concern is whether this could give rise to currency depreciation, be it intentional or the result of the monetary and fiscal policy mix, and at the cost of higher domestic inflation and the risk of tariff retaliation.
Of course, relative price shifts are not a new phenomenon; and while low inflation has been the norm in recent years, grumblings about high real estate costs have been commonplace. Question now is how this crisis will shift real estate demand, be it driven by increased home working denting demand for office space, shifts in consumer spending patterns for or new preferences in accommodation, shunning urban centres. Much may depend on medical advances, but some changes could prove durable.
Across the board, its not hard to seen potential for significant price shifts, but the question remains whether the current accommodative policy mix could ultimately drive generalised inflation across the advanced economies. It’s possible, but history suggests that high debt can just as readily drive. The balance between the two may well reside with economic structures, and coming full circle back to the 1970s, recall that wage indexation was part of the equation driving up both inflation and unemployment. Hope is that governments will shun such policies and favour education as a key component of redistribution policies to lift productivity and lower inequality, without costly inflation.