Friday, July 1

Erste AM forecasts inflation of 5% in developed economies at the end of 2021, and between 2% and 2.5% at the end of 2022

Baseline scenario: inflation does not return to pre-pandemic levels

According to the manager, the high inflation phase will last longer than expected at the beginning of next year. More and more economists and central bankers will stop referring to the rise in inflation as “transitory”, because each new and serious variant of Covid 19 will harbor the risk of new distortions between supply and demand with the consequent increase in prices.

In the base scenario that drives First AM, the current high rates of inflation will fall in any case in 2022, since the factor that generates high inflation (the imbalances between supply and demand caused by the pandemic) will gradually subside. Strong demand for goods is likely to normalize, and that bottlenecks in production and logistics are gradually resolved.

However, the combination of a rapidly closing negative output gap (rapidly declining unemployment rates), growth above potential, and the gradual normalization of monetary policy, generates an inflationary effect.

Therefore, in the baseline scenario, the core inflation rate will remain above the pre-pandemic level. First AM estimates that the inflation rate for the fourth quarter of 2021 will be around 5% (annualized quarterly data) for developed economies. For the fourth quarter of 2022, the inflation rate forecast by the manager will be between 2% and 2.5% (also annualized).

Structural risks driving inflation up

La gestora first AM he wonders if in addition to the pandemic, there are other structural forces that affect inflation. According to the entity, the risks of a structural increase in the inflation rate are related to three areas:

  • Expansive monetary and fiscal policies, they could continue to support the growth of the economy for too long, even after they have reached full employment. The outbreak of the pandemic has caused the attention of central banks and governments to focus on employment and rising inflation, a variable that has been below the target of central banks in the last ten years.
  • The deflationary pressure on goods prices that arose as a result of the opening up of China and continued for two decades, may have ceased for good. Globalization stagnates, or it could even be reversed (deglobalization). China’s driving effect on the export boom, and falling commodity prices, have lost steam.
  • At the same time, the change in the age structure of the population could favor inflation, because the size of the employable part of the population has decreased in all countries. This could lead to higher inflation due to higher wage increases. From a long-term perspective, the evolution of unit wage costs is the most important unit of measure for inflation.

Exit from ultra-expansive monetary policy

Another question posed by the manager First AM isHow will central banks react to the evolution of inflation?

In general, central banks in developed economies will raise rates towards neutral levels as they

  • Inflation expectations anchored in the target of each central bank are less solid.
  • The unemployment rate decreases and moves closer to full employment more rapidly (known as the “unaccelerated inflation rate of unemployment”).
  • The deterioration on the supply side is more permanent (because participation in the labor market decreases, and deglobalization advances).

As for the Fed, it has already announced the end of its bond purchase program for next spring, as well as three interest rate hikes throughout the year. In the manager’s baseline scenario, the ECB will leave its interest rates unchanged, but will prepare market participants to abandon the zero interest rate policy in 2023.

Conflict of objectives between central banks

By 2022, in addition to the pandemic, another major issue has emerged for central banks in developed countries. If inflation does not fall, the conflict of objectives between central banks will intensify. In this case, central banks would be under pressure to raise interest rates more significantly and earlier than expected.

But the restrictive monetary measures would negatively affect the objective parameters of growth, employment, financial stability and, for the ECB, the integrity of the euro area. On the positive side, although high inflation is no longer really transitory, inflation rates will gradually decline next year in the baseline scenario of First AM. According to the manager, it is up to central bankers to reduce the ultra-expansive stance at the appropriate speed

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