How the pandemic pushed up inflation

Eurozone core inflation came in at 1.6 per cent in August, while headline inflation hit 3 per cent. In Germany, at least, the all-important national metric went up by a notch — to 3.9 per cent.

The recorded inflation data are, to some extent, a bounce-back recovery effect — coupled with the rise in German VAT — which will distort inflation numbers from July until December. But there has been a 2.7 per cent rise in industrial goods, minus energy, which is partly a supply chain effect that could prove persistent. Food, alcohol and tobacco are up 2 per cent but services only 1.1 per cent. It is services that are keeping inflation numbers pinned down — for now, anyway. Interestingly, both France and Italy are registering inflation rates of over 2 per cent.

The governors of the Dutch and Austrian central banks yesterday came out in favour of early tightening, although it’s unlikely that the ECB will have a serious discussion on tightening next week. But opinion is shifting in the US as reflected by Federal Reserve chairman Jerome Powell’s speech last week. Based on past records, it’s doubtful whether central bank models such as the ECB’s forecasting model will capture this dynamic.

It’s now worth watching out for the behaviour of employers and unions. For example, in Germany there are reports of staff and skill shortages in some sectors; global supply chain developments like bottlenecks in international ports and shipping costs; developments in the international movement of labour; and, on the financial side, asset price developments. These indicators are pointing towards sustained increases in global inflation.

Fed board member Chris Waller has said the return of inflation surprised him. He expects inflation to be persistent, but not necessarily very high which seems, on the basis of current evidence, a reasonable outlook.

In its monetary policy review, the ECB has given itself a series of metrics by which to decide whether inflation will have returned to 2 per cent in a persistent way. The core metric will play a more prominent role in this assessment. Based on that metric, it will take some time until the alarm bells start ringing, at which point an inflation dynamic might already have set in.

The UK, as is so often the case, might be the canary in the coal mine, currently experiencing shortages of lorry drivers and fruit pickers, among others, which has led to empty shelves in supermarkets and the spectre of McDonald's running out of milkshakes. This is partly, but not mainly, an effect of Brexit. There was a heated discussion this week about whether lorry drivers constitute one of the most overpaid groups of workers — reminiscent of printers in the 1970s, which was also a period of high inflation. The pandemic has reduced the movement of labour everywhere. While there is relative optimism about the recovery in general, an exact reversal to the status quo ante in all respects seems unlikely. The times of cheap imported labour are ending.