Global inflation has peaked, but…

The Britons will, of course, be delighted if the inflation rate starts to drop again. In October, inflation reached 11.1 percent, as graph one shows; inflation was at a similar level during the beginning of the ‘80s.

But the situation is not the same. Those who remember that time know that, at the beginning of the ‘80s, people were used to inflation. Before the current inflationary period, inflation was kept artificially low for a long period, which means that the current rise in inflation is a different kind of shock. Therefore, many households, especially in Western countries, have an urgent need for inflation to level down to the desired 2 percent again. I expect the next consideration among investors is how to get inflation down to the central banks’ preferred target and how fast.

Easing price pressures

The primary reason behind my assessment – that inflation has peaked – is simply that energy prices are likely to fall to a lower level. This is completely in line with the general expectation among economists, so there is nothing distinctly surprising with that view. There is also a reasonable chance that certain food prices will rise less, which also will lead to a falling inflation rate.

Graph two shows the annual change in Chinese producer prices, which is another clear sign of easing price pressures. The reason for the lower increase in producer prices is, among other things, that raw material prices have fallen back. It is also an expression of lower demand internally in China primarily caused by shutdowns as a result of Covid-19.

When one adds up the various factors that influence inflation, it gives an overall picture of a decrease in price pressure. My assessment is that the change is enough to excite financial markets for a while, but not households, nor in the UK or elsewhere in the Western world.

My current assessment of the financial markets is “that investors are not ready for good news”. By this, I mean that even after the huge sell-off of all assets this year, the majority of investors (especially in Europe) still take a negative view of the situation. Most recently, Wall Street has shown how much the stock markets rose on marginally lower inflation than expected. Hence, my expression that majority of investors are not positioned for good news at all. The good news is that inflation is probably under control and has peaked. I expect that investors will get enough tailwind in the coming months from the development in inflation to weigh it as a positive and a buy signal.

In particular, the buzz is that the American central bank, the Fed, will be reassured. Immediately, there will be speculation on Wall Street about when the Fed will stop raising interest rates; this speculation will attract buyers. It looks different at home from the consumers, where inflation of, for example, “only” 5 percent naturally cannot elicit a smile.

Getting inflation under control

In the West, many have concluded that the economic policy pursued during the Covid-19 pandemic, where household incomes were kept up while output fell, contributed strongly to the inflationary spiral.

My finding, in connection with high inflation, is that combating it requires fiscal and monetary policy self-awareness. This is understood in the sense that high inflation can ebb away on its own, but no one should go for that passive solution. Instead, the economic and monetary decisions that led to the high inflation must be rolled back.

In the US, the central bank has admitted that it had misunderstood the strength of the labour market and the resulting purchasing power among private households. This has been corrected with historical interest rate increases to slow down an overheated economy.

Back in Great Britain, with the inflation standing at 11.1 percent, interest rates have also been raised significantly, but now comes the really bitter medicine.

The announcement from the new Chancellor of the Exchequer, Jeremy Hunt, is imminent; there will be a total package of tax increases and public savings of GBP 54 billion. The cure has two purposes: to repair the government’s battered finances and to reduce the purchasing power in the British economy to get inflation under control. All experience indicates that it will work in regard to inflation.

Germany is associated with the horror of inflation, specifically, exactly 100 years ago during 1922 and 1923; the Weimar Republic was hit by the famous hyperinflation, which was also self-inflicted. The solution back then consisted of three measures. One of them was to reduce the number of public sector employees by 25 percent.

Today, the German government, and many other continental European governments, do the opposite. In Germany, huge amounts of money in heating aid are now being pumped out to households and companies without counter-correcting public savings in other areas. This significantly increases the risk that the period of high inflation will be prolonged or that inflation will only fall back slowly.

It may very well be that inflation has peaked, but where governments and central banks participate most actively in the fight against inflation, one will find the greatest chances for a rising stock market.