Global Daily – Are inflation fears being confirmed?

Although much stronger than expected, the drivers of the rise are consistent with the view that  the re-opening of the economy is leading to some normalisation of price levels, with annual rates of inflation jumping even more given price falls when economies first entered lockdown last year. For instance, there were large gains in travel-related categories (airfares, accommodation, car rentals). Furthermore, there are some global industrial supply-side issues coming through. For example, used car prices surged, perhaps reflecting the supply constraints for new cars caused by semi-conductor shortages. Although the rise in core inflation was broader than these items, so were the price falls triggered by the lockdowns initially. Further upward pressure is likely in the next few months. However, we continue to take the view that these pressures are likely to prove transitory in nature and should fade over the next year.

For a sustained and significant rise in inflation, the economy would need to overheat and remain red hot for years rather than months. Economic growth would need to be strong enough to create capacity constraints  in the labour market. Prolonged labour market tightness would lead to a sharp and sustained acceleration in wage growth. Companies faced with excessive demand for their products and services would need to have the pricing power to pass on higher labour costs to their customers. Underpinning this process would be a jump in consumer and company long-term inflation expectations, which would encourage higher wage and price setting.

Although we are likely to see blockbuster growth in the second half of the year, economic growth will likely slow next year, to strong but less impressive growth rates. Not all the savings will be spent as they are skewed towards more wealthy households who have a lower propensity to consume. Fiscal policy will be much less accommodative next year.  Crucially, the labour market is currently far away from being tight, with the true jobless rate currently around 9%, compared to below 4% before the Covid shock. Even in 2018-2019, at low levels of unemployment, there was not much inflationary pressure. Periods of high inflation in the past – such as the 1960s – were preceded by many years of tight labour markets before inflation took off. Overall, we do not expect sustained high inflation over the coming years, but it is certainly the risk to watch. (Nick Kounis)

China Macro: Commodity boom drives up producer price inflation – The post-pandemic recovery in the global economy and in China’s domestic demand is feeding through in China’s inflation figures as well. Particularly eye-catching is the acceleration in producer prices. After having been mostly in negative territory between mid-2019 and late 2020, PPI inflation accelerated sharply in recent months reaching 6.8% yoy in April (the highest pace since October 2017). This may add to some extent to concerns over a rising contribution from China to a pick-up in global inflation. We should place this a bit into perspective, though. The acceleration in China’s PPI is strongly related to recent developments in commodity markets including metals, so in fact to a significant extent driven by global factors. What is more, there are signals that, as usual, Chinese producers do not fully pass-through higher cost prices to their customers. Although China’s CPI inflation has returned to positive territory, at 0.9% yoy in April its pace is still relatively low. And while China’s core CPI has rebounded from post-global-financial-crisis lows, its pace was also still subdued in April (0.7% yoy). Earlier this week, the PBoC stated that it does not expect the rise in global commodity prices to have a big impact on China’s CPI inflation going forward. Meanwhile, China’s credit cycle has already started turning (also see our April China update, The sky is the limit). We expect this trend to continue in 2021, although we do not foresee sharp U-turns in monetary policy, certainly not in the run-up to the CCP’s 100th anniversary on 1 July. (Arjen van Dijkhuizen)

Euro Macro: EC forecasts a further deterioration in government finances –  The European Commission (EC) published its Spring 2021 forecasts today. It has raised its forecasts for GDP growth to 4.3% in 2021 and 4.4% in 2022, up from its previous forecasts of early February, of 3.8% in each of these two years. The quarterly growth pattern during the rest of this year forecast by the EC is quite similar to our own, with GDP growing by around 0.8-0.9% qoq in the second quarter of this year, to be followed by a sharp rebound of around 3% qoq in Q3 and another strong quarter of above 1% qoq growth in Q4.

Besides the growth forecasts the EC has updated its forecasts for government finances. Compared to the EC’s previous forecasts for the budget balance and government debt ratios in 2021 the EC’s forecast have deteriorated markedly. The eurozone total budget balance is to deteriorate from a deficit of 7.2% GDP in 2020 to a deficit of 8% in 2021. The eurozone debt ratio is forecast to increase from 100% GDP in 2020 to 102.4% in 2021. Within the group of the six largest member states, wide differences appear, with the forecast for the 2021 budget deficits ranging from -5.0% in the Netherlands to -11.7% in Italy and the forecasts for the debt ratios ranging from 58% in the Netherlands to almost 160% in Italy.

Looking further ahead, the EC has assumed that part of the fiscal support measures that were rolled out during the pandemic will be unwound in 2022. Still, the structural budget balance (that is the total budget balance excluding the impact of the business cycle and excluding one-off and other temporary measures) is expected to be – 3.7% GDP in 2022, down from -1.2% in 2019 (pre-pandemic). The structural budget balances of Spain, Italy and France all are expected to be around -5% GDP in 2022 and that of Belgium around -4.5%. Broadly speaking, this means that the debt ratios of these countries will continue to rise in the years ahead unless austerity measures are implemented or, alternatively, nominal GDP growth is significantly higher than interest payments on government debt on a sustainable basis. In this respect the outlook for Italy and Spain seems a bit more favourable than for France and Belgium. Italy and Spain will each receive large sums from the European Recovery and Resilience Facility (RRF) in the next six years, which will lift nominal growth in these countries. On top of that, ECB policy measures (mainly asset purchases but also the level of the official policy rates) are expected to keep debt service costs subdued. (Aline Schuiling)