Today’s high inflation is being compared to the 1970s. However, robust consumer spending, fuelled by pandemic savings, makes for a different set of circumstances.
Certainly, recessions before the noughties followed the Fed raising its base borrowing costs, or the Fed Funds Rate to cool economic activity and bring inflation down. This time, however, we are looking for consumer spending to hold up.
We expect this resilience as people run down savings accumulated during the Covid-19 pandemic, despite the tightening of monetary conditions - in addition to raising interest rates, central banks are adjusting other monetary polices such as quantitative easing (QE).
Households still have considerable firepower, and the consumer is likely to be the mainstay of economic growth in 2022. They have a cushion to absorb the impact of higher energy costs with the excess savings built up during the pandemic, which we estimate at around $2 trillion in the US and a similar figure in Europe.
Global CPI expectation up from 3.8% to 4.7%
Russia’s shocking invasion of Ukraine – with the consequent impact on energy and food prices already seen – has certainly added a new dimension to the inflation picture. We now expect global consumer price inflation of 4.7% this year (up from 3.8%) as the impact of the war reverberates around global markets, although there remains a high level of uncertainty around the economic implications of the conflict. These are forecasts for consumer inflation as based on year-on-year (y/y) movements in consumer price indices (CPI).
Inflationary pressures, however, had already been building following the marked global economic recovery as Covid-19 induced restrictions were gradually eased. The easing had resulted in shortages of materials, energy and transport. This was coupled with very strong demand, especially for goods given restrictions around services sectors.
The pressure in global supply chains has resulted in sharply rising costs for producers of goods, who’ve in turn raised prices for the consumers of their end products. Even before Russia’s invasion of Ukraine, CPI inflation had been at its most elevated level for decades in the US, Europe and the UK.
Stagflation the more likely outcome
We are optimistic on supply chains gradually returning to normal in 2022 and can see scope for a moderation in commodity prices should the situation in Ukraine stabilise.
As inflationary pressures ease, we expect global CPI y/y inflation to fall back sharply to 2.8% in 2023, up only marginally from 2.7% forecast before the Ukraine invasion.
Recently, we have seen a pick-up in the cyclical areas such as housing in the US where shelter prices have accelerated sharply. Overall, 80% of the US CPI basket components are now rising at over 4% y/y. This suggests it is not just one-off supply bottlenecks which are driving the acceleration in inflation with cyclical prices also reflecting excess demand.
The broadening of inflation into the cyclical areas of the US economy is a concern as trends in this area can persist and may feed a wage-price spiral.
Risk of recession has gone up
Covid-19 induced supply chain disruptions had already set the global economy on a stagflationary course prior to Russia’s invasions of Ukraine. The rise in commodity prices drives inflation even higher putting a major squeeze on consumers and business. Economic activity slows significantly. The result is an even more stagflationary outcome with global growth weaker and inflation higher this year and next.
There are also other risks that could result from a collapse in consumer spending due to other factors:
The first is simply that bottlenecks prevent spending from taking place. Big ticket items such as cars are in short supply and travel is still restricted in many regions, particularly Asia. This could create another air pocket for the economy where activity dips until supply can respond. The second is that people choose not to spend their savings after all.
For now, however, the pandemic savings look to be a key difference with past economic cycles where higher inflation and aggressive tightening in monetary policy triggered a consumer collapse and recession. We are expecting consumers to be a mainstay for the global economy as they run down savings, as the world continues to re-open.
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