Rising Inflation Concerns: A Return to Price Pressures?

10th March 2021

As the global economy begins to recover in 2021, inflationary pressures are becoming a major concern. We explore whether inflation is truly returning and its potential consequences for consumers.

As the dust begins to settle from the global economic shock caused by the COVID-19 pandemic, there is a growing concern that inflationary pressures may be on the horizon. After months of lockdowns, government interventions, and economic uncertainty, the world is cautiously emerging from a period of stagnation. Governments have rolled out extensive fiscal stimulus measures, and central banks have kept interest rates at historic lows in an attempt to stabilise economies. But as economic activity begins to pick up, many are asking whether this will lead to a resurgence of inflation.

In recent months, there have been signs that inflation may indeed be making a return. In the United States, for example, consumer prices rose in January 2021 by 1.4% year-on-year, with core inflation—the measure that excludes volatile items like food and energy—also seeing a noticeable uptick. Similarly, in the Eurozone, inflation rates have been rising gradually, prompting concern among economists about the potential consequences for the global economy.

To understand the implications of rising inflation, it is important to examine the causes and potential consequences. Historically, inflation has been driven by a variety of factors, including supply chain disruptions, demand pressures, and changes in monetary policy. In the wake of the pandemic, all of these factors have come into play.

First, supply chain disruptions have played a key role in driving up prices. The pandemic led to factory shutdowns, shipping delays, and shortages of key raw materials, which, in turn, pushed up the cost of goods and services. While many of these disruptions are expected to be temporary as economies reopen, the sheer scale of the disruptions has created a ripple effect that is likely to persist for some time.

Second, demand pressures are beginning to build as economies reopen and consumers start spending again. After months of lockdowns and social distancing measures, there is pent-up demand for goods and services. This demand surge is likely to put upward pressure on prices, particularly for sectors that have been hit hardest by the pandemic, such as travel, hospitality, and entertainment.

Third, the monetary and fiscal response to the crisis has contributed to inflationary pressures. Governments around the world have injected trillions of dollars into their economies through stimulus packages and financial support programmes. Central banks have also maintained ultra-low interest rates, making borrowing cheaper and encouraging spending. While these measures have been necessary to stave off a deeper recession, they have also increased the amount of money circulating in the economy, which can lead to inflation.

But is this inflationary pressure sustainable, or is it merely a temporary blip? The answer to this question depends on a number of factors, including the extent to which supply chains recover, the durability of demand, and the ability of central banks to manage inflationary expectations.

For one thing, while supply chains are beginning to recover, they are likely to remain strained for the foreseeable future. In particular, the semiconductor shortage that has affected industries ranging from automobiles to consumer electronics is expected to persist for several months, contributing to higher prices for a range of products. Furthermore, the shift to remote working and changes in consumer behaviour have altered demand patterns, making it more difficult to predict how supply chains will adjust to new realities.

At the same time, demand for goods and services is expected to remain strong as economies reopen. In the United States, for example, the Biden administration’s $1.9 trillion stimulus package is expected to provide a significant boost to household spending, particularly in sectors like housing, autos, and durable goods. Similarly, in the UK, the government’s furlough scheme and other support measures have helped households maintain spending power, despite the economic challenges of the past year.

The key question, however, is whether this demand will be sustained. If consumer spending remains robust in the coming months, it could create inflationary pressures that persist for longer than anticipated. In that case, central banks may be forced to take action, potentially raising interest rates or reducing their asset purchase programmes to curb inflation. This could lead to a more challenging economic environment, particularly for consumers who are already grappling with rising costs.

One of the key concerns is the impact that rising inflation could have on consumers. Higher prices for goods and services could erode purchasing power, particularly for lower-income households that are already struggling with the economic fallout of the pandemic. For example, food and energy prices are expected to rise, and if wages do not keep pace with these increases, the cost of living could rise sharply.

Moreover, inflation could have a significant impact on savings and investments. For investors, rising inflation can erode the value of fixed-income assets like bonds, as the real return on these assets diminishes in an inflationary environment. Similarly, rising inflation can lead to higher borrowing costs, which could dampen investment and business activity.

In some ways, the current situation is reminiscent of the inflationary challenges faced by economies in the 1970s. Back then, the combination of oil price shocks, rising demand, and loose monetary policy led to a period of stagflation, in which high inflation and low growth coexisted. While it is unlikely that we will see a return to the extreme conditions of the 1970s, the spectre of rising inflation is certainly cause for concern.

In many ways, this situation brings to mind the famous line from Charles Dickens’ A Tale of Two Cities: “It was the best of times, it was the worst of times.” For some, the return of inflation could signal a return to economic normalcy, as the global economy begins to recover. But for others, it represents a looming threat to purchasing power and financial stability. Just as the characters in Dickens’ novel grapple with the upheavals of their time, so too will consumers, businesses, and policymakers wrestle with the uncertain future of inflation in 2021.

As we look ahead, it is clear that the world will be watching closely to see whether inflationary pressures persist or whether they prove to be a temporary blip. For now, the question remains: will the global economy recover from the pandemic without triggering runaway inflation, or will price pressures continue to build, forcing central banks to take action?

What is certain is that the world is entering a period of uncertainty, and the potential for rising inflation is a significant factor in the economic outlook. Whether this proves to be a temporary challenge or the beginning of a longer-term trend remains to be seen. But in either case, the return of inflation—whether mild or severe—will be a defining feature of the economic landscape in 2021.