A number of analysts got their inflation outlook for the last year spectacularly wrong, believing rising prices would be a transitory factor, so banking on projections for 2022 seems foolhardy at best.
Not everyone followed the example of Swiss Private Bank EFG and latterly admitted their mistakes. Even so, the lender has given itself an eight out of 10 for the accuracy of its 2021 economic predictions. So what has changed?
In November, UK inflation hit its highest level for more than a decade as supply chain disruption and record fuel prices sent the cost of living soaring.
Consumer Prices Index (CPI) inflation rose to 5.1 per cent in November from 4.2 per cent the previous month — the highest since September 2011 — and a significant rise from the January rate of 0.7 per cent.
“‘Transitory’ is a word that has been thrown around a lot over the past year or so in relation to global inflationary outlooks”, said Giles Coghlan, chief analyst at forex broker HYCM, adding that November’s UK inflation reading meant many were wondering whether that was truly the case.
Inflation expected to hit 6% by the spring
With some economists now expecting the figure to hit 6 per cent by the spring of next year, it is no surprise then that EFG adopted a more cautious tone for its 2022 inflation outlook after expecting prices to stay low in 2021.
“The hardest call for 2022 is whether inflation does prove transitory or not. We think, on balance, it will,” the bank said, with inflation in the US, UK and eurozone “falling back towards 2 per cent in the second half of 2022”.
At current levels, inflation is close to being further above the Bank of England's target of 2 per cent than at any point since the UK started targeting inflation in October 1992, with the jump to 5.1 per cent in November also taking the rate well above the lender's forecast of 4.5 per cent.
“It is just shy of the peaks of 5.2 per cent in September 2008 and September 2011. But aside from those, it’s the highest rate since March 1992,” said Neil Shearing, chief economist at Capital Economics.
Inflation is now “uncomfortably high” for the BoE, which is why the lender became the first central bank in the G7 to raise interest rates since the start of the pandemic, hiking them to 0.25 per cent in December from a record low of 0.1 per cent.
The move indicated that central banks no longer consider coronavirus the biggest threat to their economies.
Inflation now poses a bigger risk than Covid
For almost two years, the main challenge for monetary authorities has been to anticipate where the next pandemic blow might fall — and to cushion its impact on economic growth and employment.
But the BoE’s rate increase, along with the Federal Reserve’s decision to bring forward the end of its bond-buying programme and signal three rate increases next year, signals that reining in prices is a higher priority than protecting output and employment from further pandemic fallout.
“Heading into the first quarter of 2022, concerns over the economic impact of the coronavirus and high levels of inflation will continue to dictate market and policy direction alike,” said Fawad Razaqzada, market analyst at ThinkMarkets.
“Investors will want to know what steps governments and central banks might take to stem price pressures, and at the same time, keep their respective economies ticking over as the latest Covid-linked restrictions weigh on activity.”
Mr Razaqzada says investors are likely to focus on central banks when making trading and investment decisions.
“These include monetary tightening by the Fed and other major central banks, as inflation has soared across the world,” he said.
“The Bank of England is seen raising rates at least a couple of times in 2022, while the European Central Bank is set to taper its QE [quantitative easing] purchases significantly.”
The markets have factored this in, with the pace of the global stock market rally slowing and occasionally reversing in recent months — partly a reflection of reduced support from central banks and the more challenging fiscal environment facing investors in the year or years ahead, as governments have to start repaying the cost of rescuing their economies from the pandemic.
While the consensus seems to be that inflation will hit 6 per cent by the spring of 2022 before retreating once again, there is still the risk that central banks will get it wrong, warns EFG.
This could be either by overestimating the role played by demand in the rise of inflation, or underestimating the sluggishness of inflation and arguing that the fact that it stays high even though supply factors have moderated is evidence that tighter policy is necessary, EFG said.
“They may underestimate the collective amount of tightening they are doing. As a growing number of them tighten policy, the contraction of global aggregate demand may be greater than they anticipate,” the bank added.
What caused inflation to soar in 2021?
Look back over the past 12 months and the price pressures are easy to see, largely driven by supply chain shortages amid strong demand for goods as economies reopened from lockdowns, and rapidly rising commodity prices.
“Many market participants have been at loggerheads as to how to interpret the hotter-than-expected global inflation on monetary policy and in turn stock markets,” said Mr Razaqzada.
“There have been extensive debates as to the nature of the inflation — is it structural and long-term, or is it short-term and transitory?”
While the analyst believes longer-term inflation expectations are anchored and do not pose any threat to price stability, he concedes that shorter-term movements of risk assets will be largely dependent on how changes in monetary and fiscal policies are communicated to the market.
“The problem which I have observed is that central banks and governments are finding it difficult to communicate effectively with the market as to how they are seeing inflation and how they will react,” he said.
A prime example of that was when Andrew Bailey was forced to deny he was an “unreliable boyfriend” in November, after economists accused him of “appalling signalling” and of sending “muddled” messages after a 7-2 vote that kept rates at the record low of 0.1 per cent.
There are reasons pointing to inflation remaining transitory as some of the rise has been due to one-off factors.
Looking at November’s reading, for example, the 5.1 per cent monthly rise in fuel prices is unlikely to be repeated as oil prices have since fallen.
Meanwhile, a 4.2 per cent monthly rise in tobacco prices was mainly due to an increase in tobacco duties in October’s Budget, and a rise in clothing inflation “had more to do with the unusual fall in prices last November than any strength this November”, Mr Shearing said.
Evidence of more persistent price pressures
Even so, there is some evidence of more persistent price pressures, Mr Shearing added, pointing to the rise in food inflation in November, which probably reflects higher costs faced by suppliers.
“What’s more, the further acceleration in core producer output price inflation, from 7.1 per cent to 7.9 per cent (the highest rate since this series began in 1997), suggests that the rises in global costs and the influence of product shortages are still boosting price pressures further up the inflation pipeline,” Mr Shearing said.
Soaring inflation along with tougher Covid-19 restrictions amid the Omicron surge now risk triggering double-dip recessions across the globe, the World Bank warned, as countries run out of economic firepower to stifle the effects of the pandemic.
While forecasters had expected 2022 to be another strong year of recovery, the global economic outlook has clouded in recent weeks as fresh restrictions have been introduced in a number of countries, including the UK.
With Mr Shearing expecting the economy to contract 0.1 per cent in December, with a further dip at the start of next year on weaker growth if more Omicron restrictions are rolled out, there are also fears inflationary pressures could ramp up even more if weakened supply chains face more disruption.
UK households face cost-of-living catastrophe
Ultimately though, inflation of 6 per cent is a real headache for UK households facing “the year of the squeeze” in 2022 as soaring energy bills and rising taxes eat into incomes, according to the Resolution Foundation.
Some families are in line to be £1,200-a-year worse off from April when a price cap on energy bills is raised and a tax increase comes into effect, the think tank said.
Laith Khalaf, head of investment analysis at AJ Bell, expects inflation to moderate over the next three years, staying above 2 per cent for much of that time.
While interest rates will almost certainly rise again in 2022, Mr Khalaf, head of investment analysis at AJ Bell, said this will be “a Pyrrhic victory for cash savers, because inflation will rise faster”.
“As a result, money in the bank will be losing its buying power even faster. Cash therefore still looks like an uncomfortable place to be for the foreseeable,” he said.
Becky O’Connor, head of pensions and savings at interactive investor, said any inflation figure that starts with a “5” means Britons will have to budget more heavily than before.
“People are watching the prices of everyday necessities rise before their eyes. This is the kind of inflation that is felt by almost everyone, although clearly those on low and fixed incomes such as pensioners, face the toughest struggle to keep their standard of living within their budget,” she said.
As Britain heads into the first quarter of 2022, concerns around inflation are set to persist.
While Mr Shearing expects headline inflation to fall sharply from June 2022, perhaps to 2-2.5 per cent by the end of 2022, core inflation will remain uncomfortably high in a number of countries.
“The sharp increase in energy inflation, which has propelled this year’s surge in inflation, will unwind in 2022. But in most advanced economies a combination of strong demand and lingering supply shortages means that core inflation is unlikely to ease as quickly as policymakers expect”, he said.
“Some of the heat will come out of the inflation debate, but it will continue to be the key issue for policymakers and markets.”
