THE RETURN OF THE INFLATION SPECTRE - Creating Progress

THE RETURN OF THE
INFLATION SPECTRE

ECONOMIC BRIEF 10.032021

                           Creating Progress

                                        www.asacentra.com

1
The Shape of Global
Recovery

The accelerating rollout of COVID-19 vaccines in many advanced economies has set the stage for
rapid recovery in the second half of this year and into 2022. Although growth in digital and digitally
enabled sectors will level out somewhat, high-employment service industries will ride a wave of
pent-up demand. Assuming that vaccination continues to pick up globally, the most likely scenario
for the economy is a rapid recovery in the second half of this year and into 2022. We should see a
partial but sharp reversal of the K-shaped growth patterns that have emerged in pandemic-hit
economies.

While massive government programs have buffered the economic shock of the pandemic, hard-
hit sectors have nonetheless faced significant losses. Between these transitory reductions on the
supply side and the predictable surge in demand, a temporary bout of inflation is possible and
perhaps likely. But that is no cause for great concern. In the second half of 2021 and into 2022, the
K-shaped dynamic of the pandemic economy will give way to a multi-speed recovery, with the
traditional high-contact sectors taking the lead. The two lingering areas of uncertainty for health
and economic outcomes are the pace of the vaccine rollout in the developing world and
international cooperation to accelerate the restoration of cross-border travel. But with forward-
looking leadership, both issues should be fully manageable.1

Just as no one is safe from COVID-19 until everyone is, a healthy post-pandemic global economy is
not possible without a strong rebound everywhere. But, both across and within countries, the
economic recovery risks falling victim to the same short-sightedness that has hampered the global
vaccine rollout.

1. Central Banks

The world’s biggest central banks will happily live with higher inflation and investors now
aggressively betting on a quicker end to monetary stimulus are all but certain to be proved wrong.
After a decade of underestimating inflation, central bankers in the United States, Europe and
Japan have every reason keep money taps open and policymakers are even rewriting their own
rules so they can let price growth overshoot their targets. If anything, central banks are more likely
to nudge up stimulus, particularly in the euro zone, keeping borrowing costs depressed and
ignoring the inflation hawks at least until growth is back to pre-pandemic levels -- and not just
fleetingly. Even if inflation accelerates, a big if given that big central banks are all undershooting
their 2% goal, tightening policy too hastily is seen as a bigger evil than moving too slowly. 2

1
    The Shape of Global Recovery by Michael Spence - Project Syndicate (project-syndicate.org)
2
    Analysis: Central banks will happily ignore inflation-mongers | Reuters

2

                                                           The ECB is currently accelerating its bond
                                                           purchases to push back against higher borrowing
                                                           costs, reflecting a widening divergence between
                                                           the euro-area and U.S. economies. Central banks
                                                           across the region bought an average of 20 billion
                                                           euros worth of debt a week over the past two
                                                           weeks to keep financing conditions for
                                                           governments, companies and households
                                                           favorable, and Vasiliauskas signaled that investors
                                                           should expect such a pace to continue.3

If the economy recovers and fiscal stimulus turbocharges pent-up demand, a lot of bank credit
could suddenly emerge from central bank money. Price growth will then begin to accelerate, and
the European Central Bank will have a very hard time curbing it without having a functioning
inflation brake.

2. Outlook Darkens for Europe’s Virus-Stricken Economy

Economists are cutting growth forecasts for the eurozone economy as a third wave of Covid-19
infections and vaccination delays spur tighter restrictions in several countries including France,
Italy and Germany. ING now expected the eurozone economy to shrink 1.5 per cent in the first
quarter, having previously forecast a 0.8 per cent decline.
Holger Schmieding, chief economist at Berenberg, said each
month in lockdown would shave 0.3 percentage points off
eurozone growth. He has cut his growth forecast for this year
from 4.4 to 4.1 per cent, assuming a one-month delay to
reopening. Barclays economists said they now expected
European mobility restrictions to only be lifted toward the end
of the second quarter, “which will weaken domestic demand,
and consequently imports”. They kept their growth forecast for
this year at 3.9 per cent but cut next year’s from 5.3 to 4.3 per
cent.

Switzerland’s central bank will publish its 2020 currency intervention tally and conduct the first
rate decision of the year, with officials expected to maintain current policy settings with the world’s
lowest interest rate. Counterparts in Hungary, Iceland, the Czech Republic and Morocco are also
expected keep their monetary stance unchanged.

3
    ECB Governor Warns Against Sharp Policy Tilt When Crisis Passes - Bloomberg

3

Although many economists are downbeat about the short-term outlook for the eurozone, most are
convinced it will rebound strongly once enough people are vaccinated to lift most restrictions later
this year. Others point out that the rebound of global trade will boost export-focused manufacturers
in Germany.4

3. Inflation in the Euro Area

Inflation in the eurozone has jumped to its highest level
since the start of the pandemic, but it was driven by one-
off factors that will fade next year, rather than underlying
price pressures, according to the European Central Bank.
European investors will be dreading today’s flash estimate
of euro-area inflation in March, which is expected to be at
its highest in more than a year. Markets fear higher
                         inflation because it would raise bond
                         yields and interest rates, which could
                         in turn destabilise currencies and
                         asset markets. Yet the rise in inflation, caused by higher energy prices,
                         disruptions in supply chains and the eventual unleashing of pent-up
                         demand once covid-19 lockdowns have been eased, is expected to be
                         temporary. The effects of higher oil prices and supply-chain bottlenecks will
                         soon fade, but not quite yet. Europe’s recovery will be slower and weaker
                         than forecast as the continent’s roll-out of covid-19 vaccinations continues to
                         stutter, falling behind that of America and Britain. The continent is battling
                         with a particularly vicious third wave of the pandemic that could prolong
                         tight measures to contain the virus until the early summer. 5

4
    Outlook darkens for Europe’s virus-stricken economy | Financial Times (ft.com)
5
    https://www.economist.com/

4

4. Covid Resilience Ranking

                                                               The Ranking’s top four show that snuffing out
                                                               or containing Covid early continues to pay off in
                                                               quality of life. But, with the exception of
                                                               Singapore, these places are lagging on
                                                               vaccinations as low caseloads have made the
                                                               virus a distant threat. Going forward, that could
                                                               put them at a disadvantage as the economies
                                                               racing ahead with vaccination start to fully
                                                               reopen.6

5. The economic context of North Macedonia

Public finances were also severely affected by the pandemic, with support measures accounting
for about 9% of expected full-year GDP. The overall government deficit was thus estimated at 8.6%
in 2020: to cover the budget financing needs in 2020 and 2021, the government obtained a EUR 176
million credit line from the IMF, and macro-financial assistance from the EU of EUR 160 million, in
addition to issuing a EUR 700 million Eurobond. The deficit is projected at 4.5% this year and 3.2%
in 2022. As a result, debt-to-GDP increased to 50.3% in 2020 (from 40.2% one year earlier), and
should stabilize around this figure in upcoming years (IMF forecast). Meanwhile, inflation remained
stable at 0.8% in 2020, with a rise in internal demand expected to bring it up to 1.3% this year and
1.6% over the course of 2022. Tax evasion remains one of the country’s main problems, with the
informal economy creating unfair competition from unregistered companies (it is estimated that
the informal sector accounts for 18% of employment and between 30% and 40% of income). 7

6
    Coronavirus Pandemic: Ranking The Best, Worst Places to Be (bloomberg.com)
7
    The economic context of North Macedonia - Economic and Political Overview - Nordea Trade Portal