A resurgence may strike investors as unlikely now—but so did the retreat that started in the 1980sby Paul Wallace / July 14, 2020 / Leave a comment
Before the coronavirus crisis, an upsurge in inflation appeared an increasingly remote threat. Now it looks even less menacing as output has collapsed in the wake of the pandemic. But the immediate impact of an economic shock does not necessarily tell the full story. Further ahead, inflation could arise from its deathbed and punish investors who have come to take its quiescence for granted.
As economies continue to struggle in the wake of the shutdown, the short-term outlook is for even lower inflation. In June, the OECD forecast that by the final quarter of 2020 the annual rate will be just 0.2 per cent in Britain and zero in the eurozone. If there is a second wave of the pandemic later this year, inflation could become deflation.
But looking beyond the next year or so, there is a distinct risk that inflation could stage a comeback. One of the main forces bearing down on prices since the mid-1990s has been globalisation. As more and more products have poured in from low-wage Asian economies, above all China, it has been cheaper to buy goods and harder for western workers to push up pay. But that disinflationary tide of globalisation has been ebbing. The pandemic will intensify that trend as both businesses and governments heed security considerations and restructure supply chains.
Businesses are also likely to regain some of the pricing power they have lacked in the era of “lowflation.” The severity of the downturn will sweep away many of the zombie companies that low interest rates have (just about) kept alive since the financial crisis. That should make it easier for the firms that do survive to push up prices.
What’s more, expectations of price stability among consumers have been jolted. While the headline overall inflation rate sank to 0.5 per cent in May, research in June from the Institute for Fiscal Studies looked at everyday purchases of food, drink and household goods and found “an unprecedented spike in inflation at the beginning of lockdown.” The authors warned of “a possible return to stagflation”—the baleful mix of inflation and sluggish growth that characterised the 1970s.
Last but not least, there is little appetite to tackle big budget deficits and soaring public debt through renewed austerity. That will increase the…