Why my inflation expectations have gone up

By: Wolfgang Münchau

In my FT Deutschland column today, I made the point that my personal inflation expectations have gone up from something "close to, but above" 2 per cent to about 3 per cent. I cite three fundamental reasons why inflation is likely to go up in the medium term. I focus only on the eurozone. The reasons apply to the US and the UK in probably greater measure. The first, and most important reason is that the ECB is not a true price stability advocate, but a central bank whose first priority is financial stability. The reason I suspect is rooted in the national banking system, as national central bank governors - the majority on the ECB's governing council - are highly protective of their national banks. We all know that banking consolidation will eventually happen in the euro area, and that will invariably lead to the loss of dominant market shares by national financial institutions.  But the custodians of the status-quo - many central bankers among them - will first put a battle.

 

The second and third reasons apply more symmetrically to other central banks as well. Globalisation is shifting into a phase, where it is no longer strongly disinflationary, but mildly inflationary due to a rise in global demand, especially for raw materials, energy, and transport services, goods where the supply cannot be quickly expanded.

 

The third reason is a secular shift in the balance of power from profits to wages, thus reversing a trend that has started in the 1990s. This is happening because a) it has always happened in the past; the profit/wage share fluctuates, but is mean-reverting, and b) because of politics. Wage employees have suffered real income stagnation in the western world for over a decade, and there is a political backlash now to raise purchasing power everywhere.

 

What I did not mention in the article: The 3 per cent estimate is a rough guess. I totally distrust market-based inflation-expectations indicators. They tend to be lagging. It is a conservative estimate in the sense that the upside risk is lower than the downside risk. The ECB will continue to pay lip service to its oddly precise inflation target of "close to, but below" 2 per cent. This was always hollow in the light of the ECB's own performance, and it will increasingly be seen to be that way.

 

 

 

 

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