Short-term normalization …
As the first anniversary of the pandemic’s onset in the United States draws closer, the inflation rate is expected to rise significantly as its calculation will soon no longer take into account many of the strong contractions recorded last spring. This is expected to result in an increase of around 0.5% year-on-year. This base effect, associated with the recent increase in commodity prices as well as the expected consequences of the reopening of certain sectors, as the health situation improves, should push inflation above 2%. in the second trimester.
However, a rebound of this type does not justify a change in our inflation outlook: such one-off effects only push inflation up temporarily. Subsequently, the latter should in fact come under downward pressure due to excess capacities in the economy and, in particular, in the labor market; this pressure should continue, despite our strong short-term growth forecasts.
… but still no lasting increase
While the link between stronger growth and higher inflation seems obvious at first glance, other factors are also worth considering. First of all, given the scale of the Covid crisis, the economy will continue to operate below its full potential for some time, even though it is experiencing strong growth this year. Even on the basis of our constructive forecasts, US GDP will not return to its pre-crisis level until mid-2021, and it will not return to its pre-pandemic trend until the end of the year ( Chart IV).
More importantly, the recovery in employment is generally lagging behind that in production: the US economy is not expected to return to full employment until the second half of 2022. It should also be remembered that during the long expansion that preceded the pandemic, and despite a sharp drop in unemployment, core PCE inflation did not exceed the 2% mark until mid-2018 – and only slightly . In this context, we are banking on inflation below 2% for most of 2021 (Chart II) and on a more sustained recovery when the economy has largely absorbed excess capacity.
At a microeconomic level, the main drivers of US inflation, such as spending on health and housing (which account for almost half of the core PCE inflation basket – Figure III), will be also face downward pressure, and in some cases for political reasons.
The inflation of health care costs is today supported by several measures implemented as part of the American pandemic plan, such as the reimbursement of treatments linked to Covid. However, the effect of these measures should fade with the gradual resolution of the current health crisis, causing a reversal of the balance from next year. In addition, if the “Obamacare” program were extended as proposed by the Biden administration, then further downward pressure would be exerted on health care cost inflation, which would only reinforce an already existing trend. at work since the entry into force of the “Affordable Care Act” in 2010.
Housing-related inflation, for its part, has fallen sharply since the start of the crisis. Part of this decrease is due to the policy pursued by the authorities in favor of eviction moratoria and rent discounts. However, this inflation also exhibits strong cyclical characteristics, which means that the current trend is likely to continue, and that substantial gains in employment and wages will be necessary for rents to rise again.
Finally, a reduction in tariffs on imported goods, if materialized, would also have the effect of slowing inflation in the short term. Although this reduction is not yet certain, it seems possible to us given the approach adopted by the Biden administration in terms of trade policy.
Fiscal stimulus and the risk of overheating
Recent debates on inflation have focused on the USD 1.9 billion stimulus package championed by Joe Biden and the potential for economic overheating that such measures could provoke. However, this discussion needs to be put in the right context. Without a doubt, the policy package proposed by the Biden administration is substantial (although it will likely be scaled down before it can be voted on), and it has been a central part of our recent growth forecast.
This being the case, we must not forget that the United States lost nearly 4.5 million jobs during this crisis (Chart V). If we also take into account the fact that the natural creation of more than 100,000 monthly jobs is necessary for the American economy to keep pace with the country’s population growth, we can only observe the magnitude of the gap that exists today in terms of employment. The prospect of overheating activity therefore seems particularly remote in such a context.
It should also be noted that the risk of overheating seems all the lower if some of the stimulus measures envisaged would be temporary (such as the USD 1,400 checks granted to individuals), or else of a self-limiting nature (such as unemployment benefits which will decrease as the labor market takes shape). In addition, the relief funds that help finance the current vaccination campaign, or avoid layoffs in state and local government administrations whose revenues have plummeted, appear unlikely to be at stake. origin of overheating.
Structural forces and implications for monetary policy
Finally, our outlook for inflation rests on one essential element, namely that most of the disinflationary forces at work in recent years are structural in nature; even a vigorous post-pandemic recovery should not be a game-changer. Among these disinflationary forces are demographic changes, globalization, technology, declining union participation, increased central bank credibility and low inflation expectations. Therefore, it seems unlikely that a sustained recovery following an acute crisis could change most of these factors.
From an investment perspective, two variables seem key to us: the trajectory of inflation, and more importantly, the corresponding reaction of the central bank. The risk that inflation will spiral out of control and trigger a disproportionate Federal Reserve (Fed) reaction seems very limited. It has been several decades since such a situation occurred in an advanced economy with a credible central bank. Inflation expectations are well anchored (Chart VI) and central banks have the necessary tools to control high inflation (on the other hand, their resources could be more limited if deflation had to be prevented). This element only strengthens the credibility of monetary policy and anchors inflation expectations; this process works like a virtuous circle. Crucially, while central banks have sometimes reacted disproportionately to small transient increases in inflation in the past, this is unlikely to happen today. (In a separate note, we analyze the implications of the new policy framework adopted by the Fed.)
This note focuses on inflation in the United States, as it is, among the major advanced economies, the one where we expect the recovery to be fastest and where signs of inflation will appear first. It is also within this economy that a cycle of “normalization” of interest rates had taken place before the crisis (the Fed thus reduced its key rate from 0.25% in 2015 to 2.50%. in 2018). In most of the other major economies, where inflation is expected to remain very low for some time to come, this topic is still not on the agenda.