Curmi & Partners

A transitory “hump” or a “stagflation-lite” stage?

By Noelle Micallef

Maybe it really was too good to be true! The weaker growth momentum and inflation concerns has faded the over-optimism that prevailed the markets over the summer months. The spike in energy prices, supply bottlenecks, underwhelming job reports and the decline in business confidence are all threatening the recovery and contributing to month-on-month increase in price levels.

Earlier in 2021, central bankers insisted that surging inflation is purely transitory. However, last week the CPI index showed that US consumer prices rose 0.4% in September from costs, with an annual increase which matched readings in June and July as the highest in 13 years. The rise in core prices in the US hit a three-decade high of 4.5% in June. Several factors have contributed to this increase in inflation. The shortage of workers is driving up wages, thereby pressuring companies to raise prices. The global economic stimulus of more than $10trillion has boosted demand, and with energy prices on the rise, supply and geopolitical factors are also contributing to the continuous increase in prices. According to the US Energy Information Administration, US consumers are now paying an average of $3.29 a gallon for gasoline, the highest level in seven years. The steeper the energy bills, the more the probability of businesses increasing their prices.

These supply chain issues in advanced economies, along with the worsening health situation in emerging countries have led the International Monetary Fund (IMF) to be less optimistic about the global economy for 2021, although reasonable growth is still expected over the medium term. In its latest World Economic Outlook, the IMF expects global gross domestic product to grow by 5.9% in 2021, which is 0.1% lower than July estimates. On the other hand, the IMF has retained its global growth projection at 4.9% for the next year. In its report, the fund warned that although central banks can avoid tightening until underlying price dynamics are clearer, “they should be prepared to act quickly if the recovery strengthens faster than expected or risks of rising inflation expectations become tangible.”

Inflation is far above the Fed’s target of 2% annually, with Chair Jerome Powell emphasizing that the increase in prices should “abate” in 2022, bringing inflation closer to target. Having said this, minutes from the Fed’s September policy meeting showed some US central bank officials expressing concerns that elevated rates of inflation may impact longer term inflation expectations of households. It was also reported that Fed officials signalled that they could start reducing the Fed’s bond-buying programme in November and, if strong inflation persists, they may also be forced to increase interest rates.

In the EU, the European Central Bank has stated that more expensive raw materials and supply bottlenecks arising from the pandemic has caused a “hump” in the inflation outlook for 2021, which is expected to be followed by more moderate rates in 2022 and 2023. Eurozone inflation surged to a 10-year high of 3% in August, as the Covid-19 pandemic has strained global logistics through sanitary restrictions and labour shortages, which drove freight prices to record highs, making imports more expensive. The ECB expects inflation to average 2.2% this year before easing back to 1.7% next year and 1.5% in 2023.

The IMF expects that in Malta, the economy would grow by around 5.75% in 2021, and 6% in 2022, assuming further progress in global vaccinations, the pent-up demand for contact-intensive services and a gradual recovery in international tourist arrivals. It should still be noted that uncertainty is still very high, with main risks including a global resurgence of the Covid-19 pandemic and a prolonged placement in the greylisting by Financial Action Task Force.

Sluggish economic growth and high inflation are causing concerns of stagflation on the market, an economic spectre from the 1970s. Although it is difficult to compare, as inflation back then hit double digits and unemployment sat at nearly 9%, a lot of analysts are reconsidering the risks that it could pose, with some even calling this time a “stagflation-lite” period. Thankfully, history should have thought the market, central banks and economic authorities the right lessons to avoid the repercussions of such an economic state.

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.