COULD HIGHER INFLATION BECOME ENTRENCHED?

US October inflation showed a 6.2% gain from the previous year. Could higher global inflation become entrenched?

October US inflation registered an annual rate of 6.2%. Core inflation, which excludes volatile items such as energy and food, rose 4.6% on an annual basis. This suggests that US inflationary pressures are quite broad based.

In our previous June 18^th post we identified the end to the great disinflation (the downward trend in inflation) of the last thirty years. This was based on the fact that one of the key drivers of this trend, the shifting of production from advanced economies to cheaper locations in developing countries, appeared to be reversing. Indeed companies, for various reasons, seem to be shifting some production back to developed economies.

However, what we under-appreciated was the severity of the current supply chain disruptions. Consumer demand is currently strong as consumers spend their lock down savings. However, it has also exposed a lack of investment in the “old” economy due to an excessive focus on the “digital” economy. For example, investors reluctance to fund new oil wells, out of environmental concerns, has forced up the price of oil and gas. Furthermore, a lack of investment in cargo ships has sent freight rates up about 400 percent. Finally, labour shortages are being reported across a range of industries as the pandemic seems to have triggered the retirement of some older workers.

In summary, while some of the current strength in demand will dissipate the supply side constraints seem likely to ensure that inflation will stay elevated for the next year or two. Furthermore, the slow reversal of offshoring will add to underlying upward pressures on inflation. Over the medium term, say on a three to five year view, we would expect the ongoing digitisation of the economy to re-assert itself as the key force. The prospect of applying artificial intelligence to the service sector of advanced economies, think Alexa on steroids, holds out the potential for huge gains in productivity and significantly lower costs. In this environment disinflation and/or falling prices (deflation) would be the dominant trend.

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This post was written by Robin