COVID-19 update: A disinflationary shock - Part 2
Longer-term inflation drivers: Government debt financing and institutional change
- We forecast inflation to fall to around 0.5% in the main developed economies in 2020, before rising modestly in 2021. We see inflation below targets in 2022
- Most concerns for rising inflation reflect government borrowing. There is little evidence that greater indebtedness per se lifts inflation. Greater spending could boost inflation over time, but we judge spending commitments so far as insufficient to achieve that end
- Central bank balance sheet expansion aims to lift inflation. We are not persuaded by monetarist arguments that fast money growth will see inflation surge
- The long-term allows for institutional changes. We consider the prospect of changing central bank inflation targets, increased protectionism and green inflation
- We do not rule out the prospect of inflation rising over the longer-term. Indeed, we anchor our long-term inflation forecasts around central bank targets. But we see the immediate pandemic impact as likely disinflationary through 2022.
The great inflation debate continues
In the first of our two papers1, we considered the debate about the impact of coronavirus on the inflation outlook and we presented the case for a subdued outlook for Consumer Price Inflation (CPI) over the coming three years. We forecast inflation to average around 0.5% in 2020 in the US, Eurozone and UK, with Japan expected at 0.1%. We then see it rising to 1.7% in 2021 in the US, but envisage it remaining subdued at 1.5% in the UK, 0.7% in the Eurozone and -0.1% in Japan. We have not yet forecast inflation for 2022 but believe it likely to remain subdued – and below target – in each jurisdiction.
We discussed how the pandemic should impact different sectors of the economy very differently and that although the general price level likely to be muted, this would disguise greater price dispersal across different sectors. We looked at some of the specific difficulties of measuring inflation in this environment, before concluding with an overview of the system-wide approach we adopt to assess the general price level.
In this concluding note, we look at some of the longer-term implications for inflation. First, we consider the impact of government debt, government spending and central bank quantitative easing (QE) on inflation – areas of key concern to investors. We then consider a number of other institutional features that could shape the inflation outlook, including inflation targets and industrial and trade protectionism. We conclude with some observations on current market rates.
- Page, D., “Covid-19 update: A disinflationary shock – Part 1”, AXA IM Research, 10 July 2020