In the light of this week’s volatility in global stockmarkets as a signal of an unpredictable year ahead, Leyton Hunt, branch manager at Blackpool-based specialists Hargreave Hale takes a look at inflation prospects:
“Financial assets and equity markets have enjoyed strong recent performance primarily for two reasons. The first is the global economic recovery, which gathered strength during 2017.
“The second is that the world’s leading central banks have continued to underwrite financial markets by extending emergency monetary support measures, such as low interest rates.
“However, this support is potentially inflationary – low interest rates encourage higher spending which pushes prices up. Central banks may have to cut their support should price rises be too rapid. Therefore the key question for bankers and investors is how long the inflation rate will stay subdued.
“Policymakers are actually confused about why higher inflation has not already reared its head, given the underlying strength of the global economy and low unemployment.
“The key question for investors is whether inflation-dampening forces are structural or cyclical. If structural, inflation should remain relatively subdued and the monetary easing measures can be withdrawn gradually. However, if temporary cyclical forces have held inflation back, we may be set for a period of higher inflation sooner rather than later.
"If this is the case, central bankers may need to tighten the money supply (raise interest rates and print less new money via quantitative easing) much more quickly.”
He said those with the cyclical view argue that the low jobless rate and steady increase in employment will feed through to wages leading to an increase in inflation.
The structural view cites the impact of globalisation and technology, meaning low unemployment may no longer be inflationary.
"The International Monetary Foundation (IMF) has highlighted technology as being the primary force behind a decline in wages as a percentage of costs, implying that even at low levels of unemployment, firms may not need to increase wages. In the absence of wage inflation, broader price pressures may remain subdued.
"In addition, demographic forces – the replacing of older, higher paid workers with younger, cheaper alternatives – may also be restraining wage growth and by extension, inflation.
“We believe that while there may be a temporary increase in inflationary pressures, structural forces, such as automation and outsourcing will ensure they do not build significantly. Much as interest rates are unlikely to reach previous ‘normal’ peak levels, inflation will also stay subdued relative to history, ensuring that central banks can remove monetary support gradually.
However, there are many unknowns, and the potential for a central bank policy mistake has risen.”