Reflation is not stagflation

When the world’s top central bankers virtually convene at this year’s ECB Annual Forum, the scale and duration of the current surge of inflation will invariably be high on the agenda. But we continue to believe that the current cyclical price pressures are unlikely to morph into a long-lasting trend. As we first wrote in April 2021 , even though the pandemic is unchartered territory, the recent strong rebound in inflation is a product of the exceptional circumstances and hence likely to be temporary. While the reopening boost to services has eased, supply-chain disruptions since the start of the year have kept input prices and supplier delivery times at record high levels. Sharply rising energy prices have also pushed up headline inflation, which should remain elevated over the next few months as the recovery becomes entrenched.

While there is still considerable uncertainty about timing and the eventual peak, we expect the inflation momentum to lose steam in early 2022 as base effects of energy prices dissipate and transitory factors due to the re-opening dynamics, including supply-side constraints, and the impact of German VAT changes, fully unwind. In fact, month-on-month, price pressures have started declining already. Consistent with recent forecasts by the 

European Commission and the ECB, we project average annualized HICP inflation of 2.2% and 1.5% in 2021 and 2022, respectively, with negative base effects to rein in inflation pressures in the second half of 2022 following the “inflation surge” during H2 2021. Over the longer term, inflation expectations seem well-anchored. Though professional forecasters have slightly revised upwards their inflation outlooks for the next five years, even headline inflation remains firmly below the ECB’s inflation target.

It could get worse before it gets better … While the pick-up in inflation seems to have cooled over the summer, pandemic-induced supply chain disruptions have deteriorated as high demand and Covid-19 outbreaks in Asia exhaust transportation capacity, resulting in labor and materials shortages affecting especially manufacturing and construction.  

The strong surge in demand from the recovery, especially for electronics, coupled with specific supply disruptions, led to bottlenecks in global supply chains, which we estimate to have cut global trade growth in volume by more than -2pp in H1 2021.  In its recent 

Economic Bulletin, the ECB estimates that Eurozone countries lost 6.7% of goods export volumes due to bottlenecks in supply chains in the first half of 2021, driven by shipping disruptions and shortages of certain products (shipping congestions represent at least one-third of the rise in trade flow value this year, according to our in-house trade model). The ECB also finds that strong goods demand currently accounts for about two-thirds of global manufacturing delays. A still large gap between orders and production despite rising inventories and improving delivery times suggests that excess demand has amplified the impact of supply-side constraints.

Contact

Patrick Krizan
Allianz SE