Inflation will continue to rise over the next two years, according to revised projections by the OECD, which expects price increases to be significantly higher in 2021 and in 2022 than it previously forecast for most G20 countries.
Laurence Boone, OECD chief economist, said managing inflation would be “a very difficult balancing act” for policymakers. As if on cue, the vice-president of the European Central Bank promised on Tuesday to be “very vigilant” for any signs that supply-side bottlenecks and higher wages were driving prices higher than expected.
Luis de Guindos told a Financial Times online event that “there are risks of much more persistent pressures on inflation in the future” especially if the recent jump in prices, fuelled in part by a surge in energy costs, feeds into higher wage demands.
Morgan Stanley forecasts that higher European energy prices will add about 0.2 to 0.3 percentage points to eurozone inflation in the final three months of this year. A quadrupling of natural gas prices in the year to September has already prompted several governments to discuss billions of euros in aid for households and stricken suppliers.
“You have to be careful that . . . temporary factors do not lead to second-round effects,” de Guindos said, adding that many EU public sector workers have index-linked pay and pensions that rise in line with inflation.
The speed of the economic recovery has also increased inflationary pressures, the OECD said in its outlook. It is “pushing up prices to where we expected them to be before the pandemic”, the Paris based club said. “Policymakers in advanced economies should monitor these developments without delay.”
The OECD forecasts that the average inflation rate across the G20 leading economies will hit 4.5 per cent in the fourth quarter of the year, with 1.5 percentage points of that caused by higher shipping costs and commodity prices, such as energy.
Since its last forecasts in June, the OECD revised up inflation predictions for 2021 and 2022 for most countries.
The US inflation forecast in 2021 has risen from 2.9 per cent to 3.6 per cent. For the UK, the equivalent figures were 1.3 per cent in June and 2.3 per cent this month.
For 2022, the inflation forecasts have also risen sharply. In France and Germany, the forecast rose from 0.8 and 1.6 per cent in June, respectively, to 1.4 and 2.6 per cent.
Central banks around the world are now starting to wind down the stimulus measures they launched last year in response to the pandemic. This week the US Federal Reserve and Bank of England are expected to give more clues on how soon they could start tightening monetary policy.
The OECD said the most urgent task was to communicate to the public that rising inflation had many temporary features and was mostly an adjustment of prices to levels that had always been expected after temporary dips during the pandemic.
Boone said supply bottlenecks would ease as Covid-19 vaccination rates rose, especially in emerging economies. With huge pandemic-related government support largely in the past, demand was unlikely to run out of control.
Still, prices would likely settle at higher rates than before the pandemic — “and that is a good thing”, Boone said — but they would not remain as high as they were likely to go in the months ahead.
That is in sync with ECB projections, which forecast earlier this month that inflation would rise from 0.3 per cent last year to 2.2 per cent this year, before dropping back below its 2 per cent target next year and slipping further to 1.5 per cent in 2023.
Nevertheless, Boone said consistent communication on the temporary nature of much of the inflation would help prevent businesses and households from thinking it fair to raise prices and demand higher wages, which would make higher inflation last longer and become more damaging.
The ECB’s de Guindos echoed that view. “If you have a clear indexation of the economy to the evolution of a temporary shock . . . you can convert this temporary upward evolution into something much more permanent,” he said. “This is something that we should avoid.”
Governments also had a role to play, Boone said, in ending the pandemic narrative that they could finance anything simply by borrowing.
Welcoming US and European efforts to spend more on addressing climate change and digital transformation, Boone said: “It is important that governments communicate how they are going to do that. Right? That it’s not free money forever.”
US president Joe Biden is seeking to finance spending on infrastructure with higher taxes but faces a potentially difficult time in Congress in the weeks ahead.
The OECD said that, providing countries navigated higher inflation in the coming months, the good news is that the recovery had been “extraordinarily fast”, with advanced economies likely to suffer minimal longer-term damage.
This would be fine for countries performing well before the pandemic, such as the US, but not good enough for countries where recovery to the pre-pandemic path still meant high unemployment and weak growth. “Many economies will be roughly where they were before, but with more debt,” Boone said.
The outlook for emerging economies was significantly worse, the OECD said, because they are struggling with high rates of coronavirus infection and low levels of vaccination, leaving them more vulnerable to weak recovery and high inflation.
But with greater credibility in their institutions, such as their central banks, and early action to stem inflation, the OECD thought they would still emerge from the Covid emergency better than the financial crisis of 2008-09.