The bad type of inflation is here

Despite good news about vaccine roll-outs, it is too early to tell when or even whether economies will fully reopen and life will go back to “normal.”

There have been optimistic predictions about pent-up demand and it looks they some of them may be true, judging by the stories about pensioners booking holidays to spend all the cash they saved during the past year, when they largely stayed at home not doing much.

Inflation created by a surge in demand would be the “good” type of inflation: it would mean reopened businesses would have plenty of customers to work for. But that’s not here yet.

What is here, and is rather worrying, is the “bad” type of inflation: that in commodity prices, and food prices in particular.

In the last week, corn, wheat, coffee and sugar were among the commodities that posted the biggest price increases, right after US steel and liquefied natural gas in Asia, according to analysts at Capital Economics.

This type of inflation is particularly bad for two regions of the world: emerging markets, and Europe. But the US and the UK are not spared, either.

In emerging markets, food price rises have sparked riots in the past. The danger is that populations impoverished by the Covid-19 pandemic would protest again against governments unable to tackle the increase in poverty.

But this is not a problem for emerging markets alone. In Europe, companies could be the first to suffer because of increases in commodity prices, because they would eat into their profit margins.

Food prices have been increasing rapidly in some countries. Photo from FreeImages

After the shock of the lockdown forcing many businesses to rely on the state for survival, this new blow could push more of them into bankruptcy.

European Union countries with relatively large manufacturing sectors, such as Germany, but also Central and Eastern European economies, would be among the hardest hit in such a scenario.

The US and the UK would not be spared either. Poverty has increased in these countries as well, with the use of food banks, already on the rise before 2019, exploding during the pandemic.

Extreme poverty on the rise

For the first time in 20 years global extreme poverty was expected to have risen in 2020, according to World Bank predictions published last October.

The Covid-19 pandemic was expected to push between 88 and 115 million people into extreme poverty – living on less than $1.90 a day – in 2020, and 150 million in 2021.

More than 9% of the world’s population was estimated to live in extreme poverty last year, according to the World Bank. If the pandemic had not happened, this poverty rate was expected to drop to 7.9%.

To make matters worse, investors are beginning to notice the rise in inflation and are reacting accordingly.

US Treasury yields had risen to the highest level in 10 months, although they gave back some of those gains last Friday, hurt by disappointing retail sales for December and a general feeling that more government stimulus will be needed to get out of the crisis.

In Europe, the 5-year 5-year forward inflation swap rate for the eurozone, a closely-watched measure for inflation expectations, rose to the highest level in more than a year above 1.35% early last week, before moving slightly down later.

Central banks should not take all this as a signal that they must tighten monetary policy. However, governments should take note and adjust fiscal stimulus accordingly.

For instance, already red-hot property markets do not need more subsidies and tax relief. In times of inflation, property does well anyway.

Instead, governments should focus on supporting manufacturing and service areas of their economies, to ensure they are ready to go as soon as economies reopen.