Central banks are flooding the markets with money – and inflation is simply not pulling in. In Germany, consumer prices rose only 0.6 percent in May, the Federal Statistical Office reported on Thursday (May 28). In April, the inflation rate was still 0.9 percent. This means that Germany remains well below the inflation target that the European Central Bank (ECB) has issued for the entire eurozone despite the wide-open money gates. Inflation in the euro area even dropped to its lowest level since June 2016 in May: it was only 0.1 percent compared to the previous year. The central bank is aiming for a price increase of almost two percent, but has been missing this target for years.
Can it be that even now, in an era of unprecedented monetary policy efforts, inflation will not pick up noticeably? Yes, say economic experts – but not forever or at least not consistently. For the coming months and years, they predict an interplay of deflationary and inflationary phases that will pose challenges for investors.
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The global shock of demand and rising unemployment is likely to put the economy near deflation for a short time, says Peter De Coensel, bond chief at Degroof Petercam Asset Management (DPAM). He believes that the monetary and fiscal policy efforts of governments and central banks will not be without effect, but that consumer prices are only likely to rise in the medium term – and by mid-2022 they will even exceed the ECB target. The fact that many economies want to break global supply chains in favor of more regional solutions will drive prices, argues De Coensel.
Inflation remains low for the time being
As long as the corona pandemic continues, the inflation rate should remain low, says Birgit Henseler, bond analyst at the cooperative DZ Bank. “Ultra-expansionary monetary policy is appropriate against the backdrop of the deepest recession most developed countries will experience this year,” she says. Only after the crisis has ended will ultra-expansionary monetary policy affect consumer prices, she estimates. However, she does not consider this scenario to be particularly likely. “Many arguments that have depressed inflation rates in the past still apply,” Henseler points out. In May, for example, the low oil price continued to depress consumer prices. Because of the oversupply on the oil market, no major price increases are in sight for energy costs. If inflation rises contrary to expectations, central banks will prevent an overshoot by raising key interest rates, Henseler is convinced.
Deflation, inflation – there are good arguments for both scenarios, says Georg Graf von Wallwitz, head of fund boutique Eyb & Wallwitz. “Some see the end of globalization, according to which the price of goods should now rise. The others see the deep uncertainty of consumers and companies, who are no longer taking their money out of fear and are driving prices down, ”he explains. The fund professional expects deflationary and inflationary surges to alternate in the coming period.
Interplay of deflation and inflation
Alastair Irvine, product specialist at Jupiter Asset Management, has also identified indications of rising and falling consumer prices. The flood of money from central banks artificially keeps many companies alive that would otherwise have been insolvent for a long time, he says. Such so-called “zombie economies” usually suffer from deflationary pressure. On the other hand, commodity prices and investment costs should also recover together with the economy. “That, in turn, creates inflationary pressure,” says Irvine. The question is which pressure turns out to be the bigger one.
Investors face these predictions with a dilemma. As long as the economy is in a deflationary surge, it makes little sense to hedge against future inflation, for example with inflation-indexed bonds. If the rate of inflation rises, it could happen so quickly that there is hardly any time to react. The best strategy should be a diversified portfolio: bonds are among the winners in a deflationary environment, stocks and gold as real assets offer protection against the devaluation of money.
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