As inflation soars, it appears that central banks will make an abrupt change of course by tightening monetary policy hard and fast. Remember that monetary policy is anchored around the neutral rate of interest – the price of money needed to balance the global appetite to save with the desire to invest.
Surging prices over the past 18 months have been a rude awakening for central banks. In the UK, Consumer Price Inflation will reach 7% by spring 2022 and, far from being transitory, it is feeding through into wages as the idea of bills going up is baked into households’ and firms’ expectations.
Nonetheless, business investment may be entering a new phase. Since the pandemic it has recovered faster than it did after the financial crisis. That is partly thanks to government stimulus, which is now being withdrawn.
On the other side of the ledger, the world’s wish to save is unlikely to weaken. Even considering later retirement dates and the rapidly rising cost of care in old age, often funded by equity release or outright sale of a main property, the long term trend of ageing leading to more saving remains intact: rising life expectancy prompts households to put more aside for their retirement and retirees tend to run down their assets slowly.
Although there are signs of a pick-up in investment, aging populations should ensure that a plentiful supply of savings will keep a cap on long term rates.
In the long run, any upward shift in interest rates is likely to be small by historical standards. However, between now and then there is likely to be a sharp and potentially painful rise in rates. Global debt has reached 355% of GDP, making firms and households more sensitive to even small rate rises. There are few examples of central banks taming inflation without sparking a recession. The last time UK inflation fell from over 5% without a downturn was more than 70 years ago. Fighting inflation is a battle not without casualties.
Written by Runita Kholia, senior analyst at Buchler Phillips, the UK’s leading independent corporate recovery, restructuring and turnaround firm.