Enguerrand Artaz

Inflation is dead, long live inflation!

Inflation has been a key focus for market participants since the end of 2021, but attention has now shifted to the question of whether or not a recession is imminent. However, the topic of inflation may not be in the rear-view mirror for investors just yet.

This is primarily because not all regions of the world are seeing the fall in inflation witnessed in the US. While the overall inflation rate is starting to subside in the eurozone thanks to falling energy prices, core inflation continues to rise. In Japan – which was spared from soaring prices for quite some time – inflation is reaching levels not seen since the nineties or even the eighties, inciting the Bank of Japan to reconsider the ultra-accommodative monetary policy it has followed for years. Among the major economies, only China seems unaffected at present.

What China does have, however, is the spark that could reignite global inflation. The rapid reopening of the country after the abrupt end of its zero-COVID policy will revive demand, particularly for commodities. This is bound to affect the pricing of the latter given that, on average, China imports a fifth of the world’s oil, more than half of its copper and nickel, and three fifths of liquified natural gas. Unlike the US where cheques were distributed directly to households, China did not resort to a massive demand-side stimulus plan, but the Chinese nonetheless amassed substantial savings during the long quarters of lockdown. Indeed, Chinese households saved USD 2.6 trillion in 2022. This well of liquidity represents a powerful reservoir for consumer spending that is waiting to irrigate the global economy as Beijing throws open its borders.

Such pent-up demand is likely to have a positive impact on global economic growth, in particular in Europe, where many companies are exposed to Chinese consumption. But it is also likely to generate renewed disruption in supply chains, which are only just beginning to return to normal. This is especially the case since the path back to normality has been heterogeneous, with excess stocks of some products in recent months and ongoing shortages of others.

Of course, it is unclear how quickly the reopening of the Chinese economy will spread across the global economy. The woes of the domestic real estate sector persist, leaving the construction sector sluggish and curbing demand for some raw materials. Cautious spending habits adopted during the pandemic and the uncertainty of the economic outlook may temper the desire to rush out and use excess savings. Nonetheless, the risk of a new wave of inflation provoked by the reopening of China requires close monitoring, at the very moment when the issue of inflation seems to have taken a back seat for investors and financial conditions have eased considerably. This makes the task facing central bankers even more complex.

Final version of 27 January 2023 – Enguerrand Artaz, Fund Manager