Inflation is coming back but it’s no reason to panic
Eurozone economy won’t recover lost output until 2023
The prophets of doom who’ve been warning we have taken on too much debt and that interest rates are going to rise will get a spring their step over the next few months with the return of inflation.
It has been a rough decade for inflation hawks as the main concern since the financial crisis has been too little inflation, reflecting weak growth and the heightened risk of slipping into perma-recession.
Now, thanks to the pandemic and the sharpest recession in living memory, they will be ‘proven’ right.
Gabriella Dickens of Capital Economics reckons that inflation in advanced economies will surge by nearly two percentage points thanks to rising energy prices and the reversal of some Vat cuts.
Here, annual inflation has been negative since April and came in at -1pc in December.
That energy-induced ratchet higher will be amplified here in Ireland by a stronger pound and Brexit supply shocks.
There’s also the question of the additional €13bn in savings squirreled away here during the lockdowns; could a wall of spending trigger price rises?
The eurozone as a whole saw deflation of 0.3pc in the year and headline inflation in the single currency area has been negative since last August.
Most of the coming inflation shock, however, relates to the collapse in oil prices in spring of last year – lower transport prices were behind 60pc of the overall drop in Irish inflation – when the first pandemic lockdowns roiled the economy.
And that oil price shock is now going to disappear from the inflation numbers, with crude now trading at around $55 a barrel.
Investment bank ING says that this ‘base effect’ for energy prices will turn positive in April and the positive base effect from higher energy prices could bring a positive contribution to eurozone inflation of some 0.4 percentage points by May.
That compares with a negative 0.8 percentage points in November of last year.
An even bigger problem with the inflation numbers as we see them through the eyes of our sickly pandemic-stricken economies is that they don’t actually represent our current spending patterns and these changes have not been reflected in the make-up of the consumer price index.
Falling fuel prices have been largely irrelevant to our cost increases as we have been locked down at home, within 5km radius, or in our own counties for much of the past year.
By the same token, restaurant prices have become irrelevant as we haven’t been allowed out to socialise.
All this makes estimating the current real rate of inflation a bit of a mug’s game and in turn raises the prospect that we will soon be recording equally meaningless rises in inflation, even if the price trend for goods and services is stable.
Expect lots of euphoric talk of a new “supercycle” from the likes of Goldman Sachs as demand recovers and the prospect of greening the economy triggers demand for commodities, but we aren’t headed back to the era of $100 oil.
The fundamentals will assert themselves.
The eurozone economy will not reach pre-crisis levels of output until 2023, a wave of unemployment and bankruptcies is on the way and inflation will remain below the European Central Bank’s 2pc target through 2022.
If there is one consolation for the ECB, which has made systemic over-estimates of inflation, 2021 could be the first time in a long while that inflation will beat its expectations, notes ING’s Carsten Brzeski.
Close to 2pc, but no biscuit.
Irish inflation will be boosted by fuel prices and a stronger pound