By Simon Gauci Borda
Over the last few months, major global economies have registered above average rates of inflation. The narrative within financial circles has shifted since the start of the year from one concerned with the potential effects of deflation as economic output dropped following the onset of the pandemic, to one concerned about whether recently high inflation prints will indeed prove to be transitory, or more persistent in nature. In the United States, inflation rose to 5.4% during the months of June and July which eased slightly to 5.3% during the month of August. Furthermore, the Euro Area’s largest economy, Germany, also registered an increase in the prices of goods and services as inflation rose to 3.8% in July, which climbed further to 3.9% and 4.1% during the months of August and September with the September reading being the highest since December 1993. In the U.K., the situation was not much different, as inflation rose to 2.5% in June, subsequently dropping to 2.0% in July, only to rise again in August to 3.2%.
The lifting of restrictions has been the main driver behind the recent rise in inflation as pent-up consumer demand that built up during the pandemic, coupled with the increase in household savings over the same period, led to an above average level of consumer expenditure once economies reopened. Global supply disruptions, the rise in energy costs and labour shortages, as many have opted not to return to the workforce partly influenced by government aid and the perceived low level of wages, have also contributed to the recent increase in inflation.
Recently the Norwegian Central Bank was the first central bank in the developed world to hike its benchmark rate, with an increase to 0.25% from 0.00% during its September meeting, citing the reopening of society and a normalising economy behind its decision while the Reserve Bank of New Zealand also raised rates earlier this week, for the first time in seven years, to 0.50% from 0.25% over concerns on rising property prices and inflation. To date, no other major central bank has raised their benchmark rates, though pressure to do so has increased. In fact, the messaging out of the Federal Reserve and the Bank of England has recently turned more hawkish than in previous communications, with both indicating that asset purchases will decrease and rates likely to be hiked in the not-too-distant future. The European Central Bank meanwhile has adopted a more dovish approach and has decided to leave interest rates at record lows and continue with its asset purchase programmes, as inflation is expected to trail back to below 2% over the medium term weighed down by the long-standing dynamics and a fragmented recovery in the Euro Area.
Given that the data set for the recent rise in inflation is small, it may be too early to gauge whether the higher level of inflation is transitory or likely to persist. However, while central bankers remain watchful as to the drivers of inflation and its future path, financial markets have reacted negatively to the data, as evidenced by the sell-off seen in the riskier segments of the financial market. Infact, while the sell-off within fixed income markets was broad based, the sell-off in longer-dated bonds and non-investment grade debt was more pronounced when compared to shorter-dated bonds and investment grade bonds.
Going forward, while it is still unclear whether the recent rise in the prices of goods and services will persist, central banks seem to have already charted their course with the forward guidance provided, as it seems more than likely that the Federal Reserve and the Bank of England will be raising rates and slowing down their respective asset purchase programmes, while the European Central Bank is likely to remain on its current course. However, in the interim, while economies continue to reopen and countries continue with their vaccination drive, barring any unforeseen events, investors will remain focused on the inflation figures published, including other leading economic indicators, and any action taken by central banks which may negatively affect the value of financial assets.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.