The Bank of England (BoE) has raised interest rates for the first time in more than three years to 0.25% from 0.1%. The BOE will have no doubt been transfixed on inflation metrics, after a jump in Britain's consumer price index to a 10-year high of 4.2% in October (Office of National Statistics), above expectations of 3.9%. Even more so after the US recently posted an increase in consumer prices of 6.8% over the past year (Office of National Statistics), the highest in nearly 40 years, coupled with increasing consumer sentiment. However, beneath the headline inflation prints, the experience across the inflation basket has not been uniform, as consumers have shifted from services to buying goods during the pandemic. Indeed, while durable goods inflation in the US has seen a big jump into double-digit growth rates, this is a big change from the experience of the last 20 years or so, where durable goods inflation has been close to zero or at times even negative. Meanwhile services inflation has been much more muted, with services ex energy running at just 3.4% year on year in November (US Bureau of Labor Statistics). Despite the headlines then, there have been significant distortions which continue to weigh heavily on the data. Also guiding the Bank of England and other central banks around the world, is the likelihood that base effects will pull down inflation next year – indeed, oil prices which have roughly doubled since November last year are unlikely to double again, and that relative inflation driver is going to work in reverse in 2022, creating a downward force for inflation.
While rate lift-off is one thing, don’t expect a series of rate hikes ahead....
The sharp rise in global consumer goods prices since March primarily reflects a huge surge in goods demand, fuelled by stimulus measures, whilst supply bottlenecks have resulted in real GDP growth expanding less than expected in the third quarter. Despite this, the IMF’s latest estimates continues to forecast UK real (constant prices) GDP growth of 6.8% this year, following by 5% next year, which would still be some way about recent historical trend rates of growth (October World Economic Update.).
Sterling has proved to be the release valve for markets, and Cable (GBP/USD) is down to around 1.32, and towards the lows of the year. How high prices move and for how long has stretched the credibility of what ‘transitory’ looks like for some, but at the end of the day, how we define inflation matters. Inflation is not a one-step change in prices, nor is it a change in prices over a year. It is a multi-year period of sustained and broadly-spread price pressures.
Looking forward, expect inflation data to be choppy over the first half of 2022 in particular, but by the end of the year, price pressures may ease as economies more effectively respond to supply-chain bottlenecks. Cost-push inflation is unlikely to morph into sustained wage-inflation and demand-pull dynamics, whilst conscious there are still risks of sustained inflation.
The central case remains that a large proportion of the current inflation spike will ultimately prove to be transitory.
2021 has been a transition year for both economies and markets and over the next year, I would expect pandemic-driven distortions to fade. This should allow central banks and governments to move towards clearer policy goals.
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