Price pressures seem to be everywhere these days. The pandemic lulled us into a sense that the stop-start economy was here to stay. With economies now beginning to reopen, demand pressures are intensifying. That’s a good thing; but supply isn’t keeping pace. Normally, we sneer at the notion of too much growth; surely, we can accommodate that kind of problem. Well, we’re not doing so well at the moment, and price pressures are mounting. Is inflation getting out of control?
Lots of people seem to think so and it’s often the first question I’m asked by business audiences these days. More broadly, Purchasing Managers’ Indexes (PMI) are indicating rising inflation worries. The manufacturing PMI saw prices spike to their second-highest reading on record in the last few months in both Canada and the United States. Consumers in Canada seem to be anchored at the 2% level, but in the U.S. inflation expectations are rising to levels not seen in a long time.
Why does that matter? Ask any central banker, and they’ll say without hesitation that managing inflation expectations is critical when it comes to price stability. Those nasty and unforgettable moments of sky-high interest rates at the end of the 1970s and 1980s were all about getting expectations down to the mid-point of the inflation target range. And once there, it’s so much easier to keep them there.
That’s the argument some use to say that today, we’re OK. They argue that almost four decades of stable prices have well and truly anchored our expectations around 2%. That’s true—but the outsized inflation of the 1970s and early 1980s followed a significant period of stable prices—it didn’t seem to take much for prices to zoom upward then. Could it happen all over again?
Central banks generally see current inflation as temporary. The economy is restarting, we had enough capacity pre-COVID-19, so we’re just in a transitory period where getting supply chains up-and-running isn’t as easy as was perhaps generally expected. By and large, we concur—this is good reasoning, and in time, when it’s clear that we’re beyond the stop-start of the pandemic period, we can pull out all the stops and fill orders as we did before.
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Then there’s current experience. U.S. producer prices are up 6.1% year-on-year in April, while last December they were up just 0.8%. This is no mere base effect of the pandemic; monthly increases at annual rates have hit double-digits twice in the past four months and have recorded five consecutive months at well above the 2% target level.
These increases aren’t being fully reflected in downstream consumer prices, but give it time—stateside, that index is also on the march. The Consumer Price Index (CPI) was up 4.1% year-on-year in April following a steady acceleration since last August. Prices saw a crescendo to monthly annualized gains of 7.7% in March and 9.6% in April. If monthly gains are tamer through the rest of the year, say below 3%, the year-on-year increases will still be above the 3% upper limit of the target range by year-end.
Canada’s situation is different, but may well catch up. Producer prices here are running ahead of U.S. prices, up 14% year-on year. That follows a scorching five-month run of growth at a very strong double-digit pace. Core Producer Price Index (PPI) inflation is also up sharply, at 10.3% year-on-year in April.
Consumer prices in Canada are contained, but there are signs of a ramp-up. Things were pretty stable through February, but monthly gains in March and April moved the all-items growth to 3.2% from 1.1%, and core from 1.3% to 2.2% in the same timeframe. Given upstream price pressures, the higher dollar might not be able to hold consumer prices at bay for too much longer.
In our high-frequency world, what happens most recently is highly influential on our thinking. In addition, getting things up and running all at once is going to continue to be problematic, especially ahead of convincing evidence that herd immunity has been achieved. Moreover, in the rush back to full production, there are profits to be made as available goods and services get gobbled up—creating a perverse incentive to under-produce or extend the shortages.
The bottom line?
Logic suggests that there’s enough capacity in the system to get us up and running without igniting inflation. But given the noise and chaos of the past year, logic may not prevail. At the same time, there are tighter capacity limits on some businesses than on others, and the tighter ones may not have a lot of near-term wiggle room. Best to keep a sharp eye on your own supply chains, and if you can, buy a little extra—but just a little.
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