There are three distinct camps amongst today’s central banks.
Several have decided there is too much inflation around and they have started to raise interest rates. They wish to signal their independence and their anti-inflation credentials. This is despite the facts that many economies are still not recovered fully from the lockdowns and the obvious slowdown in China, the world’s second largest economy. Korea, Brazil, Mexico, Russia, Hungary, Czechia, Norway and New Zealand have all made a move.
There are a few central banks holding out to offer more stimulus. The US is worried about a possible faltering of the recovery and the Fed is still creating £120bn more a month. Japan still cannot get up to the 2% inflation target despite the obvious supply pressures in the world and continues with loose policy. There are then many other central Banks talking of ending money creation and pencilling in rate rises in the months ahead.
Their task is not easy as economies are undergoing major structural change. There is a wide range of items where scarcity and supply interruptions are causing at least temporary price pressures. There are labour markets with plenty of jobs but a reluctance or inability by people to fill them, pushing up wages in some of the scarcity areas.
Inflation the major worry
Some central bankers take fright at rising headline inflation and at the way there is no quick fix for some of the shortages. More governments worry that the recovery is fragile and that premature money tightening after a period of extraordinary laxity might trigger an unwelcome deceleration in the growth rate.
Labour markets on both sides of the Atlantic have shown stress. Instead of lockdown unemployment and underemployment creating an employer’s market to recruit people back into new roles easily, a large number of people have withdrawn from the labour market and others are holding out for better terms and conditions.
In the US, labour force participation in September was down to 61.6% compared with 63.3% pre-pandemic. Six million people were not actively looking for a job that month who might in theory be available for work. In Germany, where participation is higher, employment was still down on pre-pandemic levels and there are shortages.
A jobs market in flux
Some of the stress comes from an apparent lack of the skills needed to rebuild. The big expansion of online retailing and home delivery has created the demand for many more drivers. For some years, advanced countries had been failing to train and attract sufficient new talent to heavy goods vehicle driving. Now those who might be willing to drive can take the option of a decent package to drive locally and get home for the evening in a way the HGV long distance driver cannot.
Governments and business are having to put in new facilities, offer more training and testing and improve pay to fill the gaps. The digital revolution that was so boosted by lockdowns forcing people into remote and digital solutions for many parts of their life has spawned a big demand for digital experts. The restaurants that are re-opening need to offer better terms to find enough good chefs. There is even talk of possible future airline pilot shortages as some pilots who had nowhere to fly for more than a year have found other things to do.
It is possible this friction drives up pay in a limited number of scarcity jobs but does not quicken the overall pace of pay growth too much. The majority of workers who have kept jobs they were able to do from home may be more preoccupied about keeping some of the benefits and flexibility of home working rather than wanting to battle over pay awards.
Employers need to be conscious of the total package and approach they offer to staff, and to understand that many are out to improve their work/life balance and to multi-task as parents, with these issues having a higher priority. It is likely now that most people are vaccinated against the virus in advanced countries employers will push a bit harder to get employees to spend more time in the workplace, which might generate a bit more churn and pay drift as a result.
The nightmare for the central banks is that the need to raise pay for a limited number of scarce specialists leads to a more general pay inflation, reinforcing the price rises we are seeing from supply shortfalls and interruptions.
Energy a new worry
Now the advanced countries and China are short of energy, which pushes up the price to heat and cook at home – and this could lead for more pressure on cost-of-living increases. No-one can be sure how many of the people that have drifted out of the workforce over the Covid-19 crisis will return. Many may want to be part time or to have a range of activities that earn money but not one full-time job.
The emerging world is still in a different position from the advanced world. In Latin America in particular, inflation has remained a problem – and interest rates have stayed higher for longer to combat its excesses. Many more people remain unvaccinated, so the economies remain vulnerable to more lockdowns and more resistance to social contact by people worried about the disease. Venezuela is a reminder that you can still get to hyperinflation in this Covid-damaged world. Turkey still has a government that wants to run hot and needs to fight a central bank that wants to curb inflation.
The takeaway for investors is that central banks, on balance, will tighten more from here, and that will provide a headwind to growth. Higher rates mean lower bond prices, and also mean a more mixed share market dependent on company and sector progress against a duller background for growth. We will be watching labour markets. A move into a wider and faster pay inflation cycle would be bad news for markets.
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