William De Vijlder

Group Chief Economist BNP Paribas

The risks associated with transitory but high inflation

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Inflation higher for longer? The interplay between productivity, profit margins and pricing power

A complex interplay between unit labour costs, profit margins and pricing power will determine whether the current increase in inflation will be longer-lasting. Traditionally, in the early phase of a recovery, unit labour costs decline on the back of increased productivity. This should cushion the impact of higher input prices on profit margins. Subsequently, unit labour costs should increase but this does not imply that margins should decline. Given the strength of the growth acceleration, the fact that alternatives for meeting robust demand often do not exist and that going for market share makes no sense when faced with supply constraints, the conditions seem to be met for a rather significant transmission of higher input prices in producer output prices.

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Zone euro

Eurozone: peak growth momentum => peak in bond yields?

Historically, a very close correlation has been observed between cyclical peaks in German economic sentiment –which since the start of the euro more or less coincides with the peak in Eurozone economic sentiment- and the 10 year Bund yield. The latter tends to decline, once the peak in sentiment has been passed. Although other factors also play a role in the dynamics of long-term interest rates, the historical experience is important to keep in mind when assessing the outlook for bond yields.

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The ECB: under pressure

Judging by the recent data, the acronym PEPP that was introduced last year when the ECB launched its Pandemic Emergency Purchase Programme, could also be seen as a reference to the pandemic’s exceptional price pressures.  The upcoming governing council meeting and the new staff projections are eagerly awaited. Whether PEPP will be prolonged beyond March 2022 ultimately depends on the inflation data. It seems likely that the ECB will postpone its decision until after the summer in order to have a better view of the inflation outlook.

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Central bank inflation forecasts: ‘Trust us, we know better’

Strong belief in the quality of central bank economic forecasts enhances monetary transmission and hence the effectiveness of monetary policy. In the current environment of rising inflationary pressures, the belief of market participants that central banks have better forecasting skills should limit the rise in inflation expectations. Research casts doubt on whether such a belief is warranted. Although Fed staff projections tend to have lower forecast errors than private sector forecasts, the difference has narrowed since the 1990s. In the Eurozone, forecast errors for inflation of the Eurosystem/ECB staff projections were equal to those of the Survey of Professional Forecasters.

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william De Vijlder

Eurozone: a potential for a positive surprise in the labour market

The pandemic has caused significant job losses although government support measures have limited the rise in the unemployment rate. A further increase is expected for this year but recent survey data suggest there is a potential for positive surprises in terms of labour market developments: hiring intentions by companies are on the rise.

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Uncomfortable inflation

Usually during recovery phases following a recession, it takes quite some time before inflationary pressures begin to appear. Yet the 2020 recession was atypical, and the recovery is proving to be just as unusual. Growth should receive abnormally strong support in the quarters ahead. What if price acceleration was not temporary, contrary to the reassuring comments of the Fed’s monetary policy committee members?

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Illustration Blog 21.20

Supply bottlenecks and the inflation outlook

In countries where restrictions on mobility are lifted, demand picks up suddenly, causing an imbalance with supply, which takes more time to react, in particular when value chains are long and complex. In recent months, companies have been reporting longer delivery lags and rising input costs, but the historical experience in the US and the euro area shows that the impact on inflation should be temporary and limited. Nevertheless, in bond markets, break-even inflation has increased significantly in recent months, reflecting investor worries about the risk of upside surprises to inflation. Should supply-side pressures ease in coming months, one would expect break-even inflation to decline as well.

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Illustration EcoTV mai 2021

US: back to the seventies?

In the debate on economic policy in the United States, some observers warn we may be back to the seventies. It was a period of severe shocks – move to floating exchange rates, two major oil crises –, high and accelerating inflation and an increased role for the State.

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Serendipity lost? Working from home and innovation

Working from home is expected to have a positive impact on the level of productivity but will it also influence its growth rate? The answer largely depends on what happens to innovation. Interaction between people is key for idea generation and the exchange of information. Formal interaction can be easily organized using a variety of software applications but informal interaction is a bigger challenge. To make sure that serendipity within and amongst teams –given its importance for a culture of innovation- is maintained, a combination of working from home and onsite seems to be recommended.

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US: which insights from the ‘great inflation’ of the 1970s?

The ‘great inflation’ of the 1970s had many causes. The policy objective of full employment had already led to high inflation by the end of the 1960s. Two oil shocks and the depreciation of the dollar caused additional increases. The key factor was monetary policy, which was not adapted to the circumstances. It reflected the view that the Fed did not have a mandate to tolerate the sizeable increase in unemployment that might have ensued from the aggressive tightening needed to bring inflation under control. In addition, inflation was considered to be a cost-push phenomenon that could be addressed with wage and price controls. Today’s situation is very different. The Federal Reserve is an independent central bank and inflation expectations are well-anchored. However, letting the economy run hot is reminiscent of the 1960s.  Should inflation be above target for too long, the Federal Reserve will need to have the courage to tighten policy sufficiently despite the potential cost to the economy.

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Illustration ITW Brexit BNPP Fortis

Brexit and its economic aftermath

How does doing trade with the United Kingdom look like in a post-Brexit world? A few months after the Trade and Cooperation Agreement between the EU and the UK came into force on 1 January 2021, what is its impact on companies trade and the economy as a whole? What can Belgian corporates with interests in the UK expect in the future? My colleague Simon Gates and myself are sharing our insights in this video.

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Illustration édito 21.17

Working from home and labour productivity

One of the lasting consequences of the Covid-19 pandemic will be the way we work with more time spent on working from home compared to the pre-pandemic situation. Clearly, the possibility to do so depends to a large extent on the industry, the nature of the job but also the country. These developments would have profound implications on where people decide to live, the role of cities, the need for office space, the use of means of transport, the needs in terms of IT infrastructure (high-speed internet), etc. A priori, one would expect a positive impact on productivity, in particular due to increased worker satisfaction and efficiency. Based on recent surveys, that is also what companies seem to expect. However, empirical research shows that the impact on productivity largely depends on factors such as the IT infrastructure, employee preferences and the way it is introduced and accompanied by company management.

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Green finance

Green investments, public debt and financial markets

Limiting global warming will require huge investments, which will partly have to come from the public sector. This could lead to a crowding-out effect. Higher public borrowing requirements could push up interest rates and weigh on private investments. In the near-term such a risk seems remote. On the contrary, there could be a crowding-in effect with a reduction in climate-related risk and positive second-round effects from green public investments stimulating private investments. To reduce the risk that financial markets would exclusively focus on the impact on public indebtedness, governments should communicate clearly on the nature of their investments, insisting that they should have a return which is a multiple of the borrowing cost.

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Dépenses ménages

How to spend it? Shifting consumption patterns and Covid-19

The Covid-19 pandemic is having a profound impact on household expenditures. The volume has dropped and its composition has changed significantly. As restrictions are gradually lifted, services such as recreation, food services and accommodation, which have seen a big reduction in demand due to the restrictive measures, could thrive, to the detriment –at least relatively speaking- of spending on goods. For the strength of the early phases of the recovery, pent-up demand is an important factor. It plays a smaller role in the services sector, which could mean that countries with a larger services sector not only have suffered more from restrictive measures but could also face a bigger challenge during the recovery.

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Central banks and climate change

Central banks have become increasingly aware of the impact of climate change on price and financial stability. Moreover, by accepting collateral or via asset purchases, central banks are taking explicitly climate risks on their balance sheets. At the European Central Bank, climate change has become integral part of the monetary strategy review launched in 2020. A major question is whether climate objectives should be pursued in the conduct of monetary policy. The fear is that it could be seen as “mission creep”. At a minimum, one would expect the ECB to ask for more disclosure concerning climate-related factors for assets held on its balance sheet. But the question to what extent market neutrality should be abandoned in favour of greener objectives is still open. The outcome of the review should be announced in September 2021.

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EcoTV Avril 2021

Spring is in the air

Economic statistics for the first part of this year are better than expected, including in Japan and the euro area. Moreover, this development is broadening in terms of sectors. Looking at business surveys, there is a growing feeling of beginning to “see the light at the end of the tunnel”.

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Illustration édito EcoP

Growing certainty that there will be less uncertainty

In many countries the number of new Covid-19 cases has begun rising again, forcing governments to maintain or tighten health restrictions. This is the case for the Eurozone, among others, where a true rebound in growth and demand has been postponed yet again. The timing of the recovery will depend essentially on the effectiveness of restrictive measures and the acceleration of vaccination campaigns, but also on spillovers effects with some of its trading partners whose economies are picking up more rapidly. The United States is one such country thanks to its successful vaccination campaign and the enormous recovery plan that has just been launched. America’s influence is not limited to providing greater opportunities for European exporters. The upturn in US bond yields has partially carried over to long-term rates in the Eurozone, pushing them higher. This trend largely reflects higher inflation expectations, although the Federal Reserve is convinced that the surge in inflation will be short-lived. Companies and households should welcome the bond markets’ jitters, which clearly signal the sentiment that the economy really is improving.

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Printemps - bourgeons

Eurozone: green shoots of recovery

The emergence of spring mirrors the improvement in economic data in the euro zone. When looking at the recent flash PMIs, one cannot but be impressed by an improvement far bigger than what was expected by the consensus. The manufacturing PMIs are also reaching a very high level and sometimes historical levels. Services have also improved, however the level is still lower than the long-term average.

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After disconnecting, will money supply growth and inflation reconnect?

Since the Great Recession, the monetary base in several advanced economies has seen a considerable increase, driven by the creation of bank reserves at the central bank. Yet, contrary to what had been observed in previous decades, this has not been followed by a significant pick-up of inflation. Following the global financial crisis, the demand of the banking system for central bank reserves increased a lot. This was a reflection of the dire state of the economy and money markets as well as tighter liquidity requirements. Subsequently, quantitative easing caused an increase in reserves on the initiative of the central bank. Going forward, as the economy strengthens, money supply growth and inflation could reconnect on the back of an increase in money velocity or faster credit demand growth. Central banks have the tools to address this, if need be. Clearly, asset markets might be less relaxed about such a prospect.

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US: nail-biting about the near-term inflation outlook

In recent months, purchasing managers in the euro area and the US have reported a significant increase in input prices as well as longer delivery lags. They reflect the next stage of the disruptive impact of the pandemic with supply struggling to meet the pick-up in demand. According to an Atlanta Fed survey, firms experiencing the most intense disruption tend to be those with the highest expectation of future inflation. It remains to be seen whether this will convince them to raise prices. The Federal Reserve is relaxed about this but, nevertheless, there will be lot of nail-biting in the second half of the year as US inflation data are released in an economy that should be able to close its output gap quickly.

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US: trying to read the mind of the Federal Reserve

The new economic projections of the FOMC members reflect a big but temporary boost to growth from the fiscal stimulus and the normalisation of economic activity as the adult population is vaccinated. They expect a limited, temporary increase of inflation. Four participants now expect that the circumstances would warrant an increase in the federal funds rate next year. Seven expect this to be the case in 2023. Fed chairman Powell was quick to point out that the projections are not a committee forecast and that the data do not justify a change in policy. This message clearly anchors short-term interest rates, whereas longer-term bond yields fluctuate on the waves of ease or unease about where the federal funds rate could be several years into the future.

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About William De Vijlder

Group Chief
BNP Paribas
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