Spectre of inflation returns to haunt economies

Massive consumer spending and supply chain bottlenecks are pushing prices higher

The giant quantitative easing projects undertaken by central banks in the wake of the 2008 financial crisis may have rescued the global economy, but they also stoked asset price bubbles in several sectors. This had the unintended consequence of accelerating income inequality in many countries. Because rich people tend to own more assets – homes, shares, cars – they become wealthier when the value of these assets rise.

Income disparity has been one of the defining trends of the past decade, and is central to the breakdown of establishment politics – from Trump in the US to Brexit in the UK.

In Ireland many young workers here are earning less – in real terms – than their counterparts did in the 1990s and 2000s, and their situation is compounded by higher housing costs.

Maybe it’s a stretch to blame all this on the medicine administered post-2008 – there are other factors – but it’s interesting to consider what the unintended consequences of dealing with the current Covid crisis might be. The obvious one is inflation.

Prices have skyrocketed in the past few months – on everything from building materials and fuel to hotel rooms and airline tickets – fuelled by a massive post-lockdown rebound in consumer spending and supply chain bottlenecks. Brexit red tape is also a factor.

Apple is reportedly asking suppliers to ramp up production of its next-generation iPhones by 20 per cent to cope with additional demand. Supply shortages have stalled the production of several top-selling car brands, with waiting lists now running to months.

Euro zone inflation surged to a 10-year high of 3 per cent in August, with further rises likely to come, challenging the European Central Bank’s benign view on price growth.

Inflation in Ireland also hit a 10-year high of 2.8 per cent last month, driven by a rise in the cost of transport, housing, restaurants, hotels and alcohol, figures from the Central Statistics Office (CSO), published last week, show.

The cost of petrol and diesel rose by 12.5 per cent and 13 per cent respectively in 12 months to the end of August, while the cost of housing, the perennial bugbear, rose on the back of a 4.5 per cent rise in rents. And remember most of Dublin is in a rent pressure zone, which should, in theory, moderate rent price growth.

Costs of business

The figures come amid a series of warnings about rising costs for businesses in several sectors. More than two-thirds (71 per cent) of SMEs in the food sector here have reported an increase in costs, from transport and energy to raw materials and packaging. It is "an issue – in some cases – that could contribute to food price inflation in the coming months", a report by professional services firm Ifac warned last week.

The acceleration in prices is linked to the sudden resumption of economic activity after lockdown, higher oil prices and supply-side lags. It is also been fed by the unprecedented amount of fiscal stimulus flooding economies.

The European Central Bank (ECB) insists the current rise in inflation is transitory and will abate once supply disruptions and base effects from earlier months wear off, but many are now arguing against this prognosis, suggesting it may prove "stickier" than regulators suggest.

Larry Fink of BlackRock, the world's largest money manager, says he doesn't believe the surge in inflation gripping the world will be fleeting, while Deutsche Bank is warning of a global "time bomb" coming due to rising inflation.

It also believes the inflation could resemble the 1970s experience, a decade during which inflation averaged nearly 7 per cent and was well into double digits at various times.

One of the other big drivers is the additional purchasing power of consumers backed by savings built up during lockdown. Between the first quarter of 2020 and the first quarter of this year, total household deposits here, a proxy for savings, grew by around €18 billion.

Subtracting the pre-pandemic deposit trend gives €10 billion of what could be termed “excess pandemic deposits” – that is the growth in deposits above the pre-pandemic trend – which equates to 8 per cent of household disposable income, the Central Bank says.

By way of comparison, the value of matured funds in Special Savings Investment Accounts (SSIAs) in 2006/07 was €16 billion. The unwinding of those schemes poured petrol on an already overheating Irish economy at the time.

Amassed lockdown savings are likely to flow out over multiple quarters, maintaining upward pressure on prices for perhaps longer than expected.

Supply chains

There is also a school of thought that believes the race-to-the-bottom globalisation that we’ve had for two decades, which has effectively exported price growth, may be at an end as businesses rethink their supply chains and consumers demand greater ESG (environmental, social and governance) standards.

The typical response to inflation is for consumers to spend more now rather than wait until prices have risen, which fuels further price growth in a sort of self-perpetuating cycle.

Inflation and its sidekick, higher interest rates, have become the bogey men of economics. So much of the global economy – stock markets, company earnings, government debt, mortgages – is predicated on their absence.

Deutsche Bank is warning that a hike in interest rates could cause havoc in a “debt-heavy world”, spurring financial crises in emerging economies.

Even a fractional change in rates would greatly alter the interest paid on the national debt here, which will be close to €240 billion this year, and would be punishing for those with big mortgages.