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Double-digit inflation rates are a thing of the past | Larry Elliott


Flared jeans. Fawlty Towers. Abba churning out No 1 singles. It has been a long time, but the explanation for the severe bout of jitters on global stock markets this week comes down to a word that was on everybody’s lips in the mid-1970s: inflation.

Inflation, the preoccupation of prime ministers from Harold Wilson to Margaret Thatcher and of US presidents from Gerald Ford to Ronald Reagan, was considered yesterday’s problem. News this week has forced investors to rethink that comforting assumption.

The US reported the biggest one-month jump in consumer prices since the early 1980s, when the head of its central bank, Paul Volcker, tamed inflation at the cost of a deep recession. In China there was evidence that rising commodity prices are pushing up costs for manufacturers. The costs of iron ore, a key component for steelmakers, and copper, used in a wide variety of manufactured goods, have soared. In the UK, the Bank of England’s chief economist, Andy Haldane, warned that a bout of unwanted inflation could turn a post-Covid-19 boom to bust.

Some see concern about rising prices as a sign of success. Tom Stevenson, investment director for personal investing at Fidelity International, said: “Remember, the fears about inflation have been triggered by the strength of the economic recovery. That’s fundamentally good news.”

Economists are, however, now split into two camps. Inflation hawks think that too much stimulus has been provided by central banks and finance ministries. They point to rock-bottom interest rates, rapid growth in the supply of money, Joe Biden’s multi-trillion-dollar fiscal packages and say it will all end in tears. One definition of inflation is of too much money chasing too few goods and for hawks this is a textbook example. Tim Congdon, a monetarist economist, predicts that inflation in the UK next year will be between 3% and 6%.

Inflation doves say the world is a different place from the 1970s, when trade unions were stronger and the global economy was less integrated. With unemployment high, the doves say there is little prospect of workers being able to secure higher pay awards even when prices are rising. Only if there is clear evidence of knock-on effects on wages should policymakers start to fret, and a big pool of unemployed or underemployed workers means that this will not happen.

Up until now, central banks have been firmly in the second camp. They are keeping an eye on inflation but think a bigger risk is of withdrawing policy support too soon, so will tolerate a period of rising price pressures they believe is temporary.

The Bank of England, the Federal Reserve and the European Central Bank have gone out of their way to say that they are in no hurry to raise interest rates or sell bonds. The expectation of continued support from central banks explains why share prices have been so hot.

The concern in markets this week is that Haldane’s view that central banks need to ease back on stimulus might become more widespread. If financial markets can no longer rely on policy remaining supportive, a key prop for share prices is knocked away. Hence this week’s wobble.

Haldane’s worry is that the UK economy will grow too fast as pandemic restrictions are lifted and that inflation could rise above its 2% target for a protracted period. Writing in the Daily Mail, he said: “Inflation inflicts collateral damage on our finances, squeezing the purchasing power of our pay and causing rises in the cost of borrowing. And experience during the 1970s and 1980s demonstrates that, once out of the bottle, the inflation genie is notoriously difficult to get back in.”

Not even the most avid hawk is expecting inflation in the UK to get close to the peak of almost 27% reached in 1975, but there are certainly reasons why price pressures will increase in the short term.

A year of lockdown-enforced stop-go means that a considerable pent-up demand is being unleashed. The supply potential of economies has been cut by the pandemic. When demand exceeds supply, prices rise. The fact that inflation was depressed last year by the battering that economies were taking during the first wave of Covid-19 makes the problem look worse than it is.

Responding to the news of higher US inflation, Mark Haefele, chief investment officer at UBS global wealth management, said: “We think it highly likely that the uptick in inflation driving the recent volatility will ultimately prove short-lived. The latest rise in inflation, in our view, reflects year-over-year comparisons, which will fade.”

Even so, central banks have a mandate to ensure price stability and may need to recalibrate when they will need to withdraw stimulus. There will be no sky-high interest rates as there were under Thatcher and Reagan, but even the prospect that they may be thinking about toughening their stance will be enough to keep markets extremely twitchy.



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