Monthly Investment Strategy

COVID-19 update: A disinflationary shock - Part 1

  • 10 July 2020
  • 3min read

Key points

  • The inflationary impact has been one of the most debated macroeconomic effects of the COVID-19 shock. The virus is likely to have different effects on different sectors and result in a greater dispersal of prices.
  • Some sectors will suffer supply-capacity reduction from measures to contain the virus. But these sectors are likely to be less than one-third of consumer price baskets. Even here, it is not clear demand will outstrip pared supply.
  • The virus presents other difficulties in analysing general price change – missing data, changing consumer weights and quality adjustments. On balance, we expect these will weigh on recorded inflation over the coming years.
  • Our broader assessment is that the pandemic primarily presents a demand shock, that is likely to dominate over the next few years, weighing on inflation and threatening a fall in inflation expectations.
  • We forecast 2020 inflation averaging just 0.4% in the Eurozone, 0.5% in the US, 0.6% in the UK and 0.1% in Japan. Base effects should see changes in annual rates for 2021 to 0.7%, 1.7%, 1.0% and -0.1% respectively.

The great inflation debate

Of all the economic uncertainties that the COVID-19 pandemic has raised, the most confusion appears to be focused on inflation. Amidst the ambiguity over the scale of the economic shock, reactions to the size and nature of policy responses, concerns about post-lockdown life and speculation over what a post-pandemic world will look like, we have been witness to a range of expectations over the inflation outlook.

In this first of two papers, we attempt to sift through the different and overlapping arguments surrounding this issue. It is our view that the impact of the pandemic will be a net disinflationary shock. We hold that view with conviction for the short-term (2020) and believe it will add to the already subdued inflationary environment – prevalent over the past decade – in the coming years (at least through 2022), although we acknowledge that base effects will tend to lift annual inflation rates in 2021.

Of course, central banks are working hard to lift inflation in many key jurisdictions, in line with their target mandates. Over the longer-term – beyond 2022 – we expect some success. There are also several interesting and insightful conversations taking place about long-term structural adjustments to the global economy. Materialisation of some of these factors over the coming years may lay the groundwork for inflation to rise and possibly exceed targets over the longer-term.

In this paper, we first look at the number of complications surrounding the short-term inflation outlook, including the consideration of bottom-up effects that we expect to deliver an increase in price dispersal, despite general price disinflation. We then consider a top-down assessment, to consider more systematically the influences on the general price level over the medium term, rather than individual sectors.

In a companion paper1 , which follows this note, we will consider the longer-term inflationary prospects, including official stimulus, the increase in government debt and central bank balance sheets as well as broader institutional change that might arise over the coming years.

  • Page, D., “Covid-19 update: a disinflationary shock – Part 2: Longer-term inflation drivers: government debt financing and institutional change”, AXA IM Research, July 2020

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