Will inflation happen in 2021?

Economic Update

Press coverage

The Times, 22nd May 2021
What should investors do through a summer of inflation? Read full article here.

What happened in the first quarter of 2021?

Stock markets around the world rose modestly in the first three months of 2021. In something of a turnaround from the position last year, the UK led the charge, up around 5%, with global stocks a little behind. Bonds had a bad quarter as rising economic optimism led to bond yields increasing (which, mechanically, means prices falling).

What can we expect for the next quarter?

"To my knowledge, there is nobody on earth who can successfully predict economic growth and inflation (to a statistically significant degree and with consistency over time). And yet, there are times when a prediction seems to be conventional wisdom, as commentators become believers in some prophecy or other. This year, it is a prophecy of doom in the form of high inflation." John Butters, CIO, Weatherbys Private Bank.

Is inflation on the horizon?

The inflation-doom prophecy also gained currency after the global financial crisis of 2008-09. At that time, many people believed that quantitative easing (QE) and an increase in money supply would create a major inflation problem. It didn’t, and the reason was simple: QE creates bank reserves at the central bank – but this is not a kind of money that the public can spend. Indeed, so-called M3, a broad measure of the money available in the economy, grew by only 2.6% in the UK in 2009 while QE was in progress, compared to growth of 17.8% in 2008 and 12.6% in 2007. After 2008, there wasn't big inflation partly because "useful money" wasn't created – the Bank’s QE got stuck in the financial system and didn’t really make much of a difference to households and businesses.

Are things different this time?

Somewhat. Compared to the aftermath of the 2008 crisis, the banking system is stronger; government stimulus has been more aggressive and has found its way into the hands of those who are most likely to spend it such as households and businesses, and debt levels will be more manageable if the economy rebounds quickly. With regard to money, the growth of money available in the economy has been on the high side in the UK and eurozone, and in the US has rocketed to 27% in the year to February 2021. These factors do make inflation more likely than in the post-2008 period.

The inflation argument is far from watertight

First, as the post-2008 period shows, the relationship between money supply and inflation has been weak in the 21st century so far. Second, inflation can be controlled by central banks. That position doesn't change until central banks stop controlling inflation, or politicians stop them from doing so. Inflation is a political phenomenon.

"We are investors, not forecasters, but we do tend to think that as long as the central banks are allowed, and indeed required, to prevent it, inflation-doom cannot be anywhere near as certain as its prophets would have us believe."
John Butters, CIO, Weatherbys Private Bank

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