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More than one year from the onset of, what would become a global pandemic, the world is slowly starting to return to normal activity levels. Thanks to a progressive vaccine rollout, we have seen the gradual reopening of economies and a recovery in business activity.

While this return to normality is welcomed, the gradual reopening of economies – alongside the vast amounts of fiscal stimulus deployed over the past year – does threaten to push global economic growth above potential levels. This will trigger inflation.

The big question is: how concerned should we be about this possible overheating?

We believe this is a temporary rise that we should accommodate over the coming months, rather than a long-term effect. Two factors drive this view: prices are rising off a low base compared to last year and the increases in inflation since last summer seem to be primarily due to supply issues.

Consider that:

  • Global suppliers struggled to predict demand for their products as countries were caught in a stop-and-go pattern of reopening. This created shortages in areas such as semiconductors.
  • Containers and container ships which had been taken off circulation were not made available quickly enough as the world started to reopen. This created a situation where global supply chains were not functioning in the way they normally could.
  • When Covid-19 hit, many businesses decided to run down their stock levels to preserve their liquidity buffers. Subsequently, as economies reopened, these low stockpiles had to be replenished.

For us to change our view, we would need to see a move towards a demand-driven imbalance between supply and demand. If there is a persistent increase in demand to which supply cannot easily adjust (if it is already operating at full capacity) it can lead to persistent inflation.

Why has the Fed sent a signal?

The US Federal Reserve (Fed) does not seem to be overly concerned about inflation (yet). Part of the reason is their belief that they have the policy tools – from forward guidance to rate hikes – to control excessive inflation.

In June, the Federal Open Market Committee sent a clear signal that they are in control and will respond accordingly to ensure long-term growth, full employment and crucially, keep inflation in check, despite all the uncertainties. They predicted interest rate rises in 2023 instead of 2024.

That is why we believe we are witnessing a short-term inflation rise, followed by an easing in underlying price pressures through the course of the year.

To find more about the latest house views from London & Capital’s Investment Desk, read the full AndPapers Q3 2021 here.

To get in contact with London & Capital, please give us a call on +44 (0) 207 396 3388 or get in contact here.

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