When it comes to inflation, central banks talk about different things

1479
7
When it comes to inflation, central banks talk about different things

Analysis-CEOs and Central Bankers talk past each other on inflation Federal Reserve Chair Powell testifies at Capitol Hill in Washington from Capitol Hill.

FRANKFURT LONDON - The bosses of top multinationals are worried about rising inflation but the very people responsible for keeping price growth in check - central bankers - seem unfazed.

Even as policymakers at the U.S. Federal Reserve, European Central Bank and elsewhere diverge on how quickly to wind down massive pandemic stimulus programs, they agree one thing: the recent inflation surge is not a major concern.

Yet the latest set of corporate earnings calls are replete with mentions of the word inflation, with the tally up 1,000% on the year for Stoxx 600 U.S. companies and 400% in Europe for S&P 500 U.S. companies, according to Bank of America research.

The fact is that when CEOs and central bankers talk about inflation, they are mostly talking about different things. The following piece describes where they differ and under what circumstances their interpretations could start to converge.

Inflation is the buzzword of the second quarter earnings season as companies grapple with price pressures stemming from large pandemic hits to supply chains struggling to cope with demand surges in all aspects of the news cycle.

Industrial conglomerate General Electric, bike-maker Harley-Davidson, consumer conglomerate Unilever Plc, car-maker Renault and pharma group Bayer have all been at pains to tell investors what they are doing about substantial increases in their input costs.

Among the big central banks, the hot inflation issue has been the most pronounced for Federal Reserve. Its highest level of price pressures is well above its target at 3.5%, the preferred measure in three decades. In June, consumer inflation hit 4.5% in the headline.

While some policymakers are beginning to recognize that price pressures are transitory than they first thought, the Fed as a whole has decided that this is sticking to the line that it is stickier.

Chair Jerome Powell said last month that the factors driving prices higher now - a 20% surge in used cars from last year or a 25% bump-up for airline tickets - are unlikely to be repeated in perpetuity. We're anxious, like everybody else, to see that inflation pass through, Powell said.

Inflation slowed, although this increase is expected to be mostly temporary. The outlook for inflation over the medium term remains subdued, says ECB President Christine Lagarde on 22 July.

And inflationary pressures are still nowhere to be seen as far as the Bank of Japan is concerned. It points to factors like weak household spending to predict inflation will fall short of its target of 2% at least until the year ending in March 2024.

For starters, CEOs are focused on their own sector while central bankers worry about the economy at large. The difference is significant: tech firms, for example, account for nearly 30% of the capitalization of the MSCI USA equity index but make up just 10% of U.S. GDP, the Bureau of Economic Analysis estimates.

Moreover, contrary to popular belief, stock markets are a poor proxy for their domestic economy, especially in Europe. Listed companies in Europe generate more than half of their sales outside their home region, compared to 30% for U.S. equities.

Moreover, central bankers are inclined to take complaints of larger organisations about price pressures with a pinch of salt; they know that, unlike the larger companies that make up the backbone of the economy, the larger ones have the power to influence and hedge price developments in their supply chain.

More fundamentally, central bankers in the United States and the Eurozone are wary of repeating mistakes of the past decade, where they tightened policy at the earliest signs of increasing price pressures that never fully materialised in the end.

And they have even talked about the merits of running the economy hot https: www.ecb.europa.eu press inter date 2021 html ecb.in 210729 1 d 0 a 024 e76.en.html - that is, letting inflation overshoot their target for a while to give the labour market time to get back in shape.

Producer prices in developed economies have been rising by 5% to 10%. However, to what extent companies can pass on higher cost to consumers is less clear.

Not yet, this is happening in the United States: Several firms from Starbucks to Procter Gamble Co and are planning to do so or are offering to.

Yet while two-thirds of Japanese firms are doing the same, according to a Reuters poll, a slim majority still did not expect that to raise the final price tag of their products in the second half of the year.

Similar picture in the euro zone: some firms contacted by the ECB https: www.ecb.europa.eu pub economic-bulletin focus 2021 html ecb.ebbox 202105 05 16 d 6 f 14 d 2 b.en.html expected some pass-through of higher input costs but firms in the services sector saw stable prices ahead.

For central bankers the litmus test of whether price rises will be sustained is whether they start pushing wages higher. This picture differs across the main regions.

Wages in the Eurozone were up a modest 1.5% in the first quarter of the first quarter. Cash earnings in Britain are at a mid-pandemic level and recent increases in Japan and Australia are expected to flop out.

Even in the United States, where wages and salaries have been increasing throughout the pandemic and were up 3.2% year-on-year in the second quarter, the Fed remains sanguine.

I think we're some way towards reaching the full employment goal, Fed chair Jerome Powell said on July 28.

Oil prices, which briefly turned negative last year, have rebounded to push up headline inflation around the world, making the year-on-year percentage change look huge even though they've returned only to more normal levels.

Central bankers like to filter out such volatility, since it comes and goes, and focus on so-called core inflation that strips out energy and food prices. On this measure, prices rose on 0.9% in Japan last month and fell by 0.2% in the Euro zone in June.

U.S. core consumer prices, the Federal Reserve's preferred inflation measure, have been increasing by more than 3% year over year but even this has been blamed on supply disruptions with containers still stuck in long queues in Asian ports.

Arguably even American consumers, whose views on inflation are typically informed by things like swings in gasoline prices, buy into this logic.

An annual University of Michigan survey shows that while they expect price increases over the next year of roughly 4.7%, that drops to just 2.8% in a five-year horizon - squarely in the range of the past two decades.

If the current surge in prices lasts long enough to affect wages and people's expectations about future inflation, then chief executives will have won the day and central bankers will adjust their stances and ultimately their policy.

For now they are betting that this won't be the case, notably in economies where the population is ageing, such as Japan, and unemployment is high, such as parts of the euro zone. Over 70% of the economists polled by Reuters agree.

A structural inflation cannot be allowed to become temporary inflation, said the ECB's de Guindos. Hence far, there have been no indications that this is the case, but we should remain vigilant.