Do we need a recession to control inflation?

Do we need a recession to control inflation?

One of the aftereffects of Covid is high inflation almost everywhere in developed markets. Some of this inflation is temporary bottle necks, but more sustained price pressures have emerged in the job market. While the US is leading the pack, the economic recovery is visible across developed markets. Even as inflation surges, consumers could fund several years of strong consumer spending growth from savings built up during the Covid crisis. Companies are also spending, including increased investment. And it’s not just developed economies, the economic recovery is also visible in emerging economies. Focusing on the US, interest rates look too low, far too low in my view. Indeed, if the Fed does not increase the pace of tightening the risk of recession in 2023 will rise. Like driving a car towards a bend in the road, failing to ease off the accelerator in good time can risk having to slam on the brakes, swerving the car into a recessionary ditch!

Growth and inflation

Omicron lessons from Denmark
  • Reported case fatality rate (CFR) is 4.5 bps compared with 5-10bps for ‘flu. Adjusted for ‘dying with’ rather than ‘dying from’ Covid, CFR falls further (by 40% says a
  • University of Copenhagen study). Antivirals cut the number further – by 80%.
  • The best guess is that new variants from now on will be more transmissible but less severe, and we almost certainly won’t see anything like the same lockdowns which we suffered in 2020.
  • This suggests that the impact of covid on economic is disappearing.

Wages are rising rapidly in the US

Wages are rising rapidly in the US

Source: Columbia Threadneedle Investments and Atlanta Federal Reserve as at 17-Feb-22

  • One of the aftereffects of Covid is high inflation almost everywhere in developed markets, with Japan a notable exception.
  • Some of this inflation is clearly temporary bottle necks, but as these ease more sustained price pressures have emerged.
  • Wage inflation has recently exploded. The graph shows a data series that is very influential with the Fed, so I include it every month in my webinar.

In aggregate UK consumers have built up huge excess savings

In aggregate UK consumers have built up huge excess savings

Source: Columbia Threadneedle Investments and Bloomberg as at 08-Feb-22

  • With consumers and companies both well stocked with cash and the economy recovering, the rise of inflation has done little to dissuade them from spending.
  • Consumers have accumulated huge spending power from the massive fiscal packages and the restrictions which meant they couldn’t spend in the normal way. Even if only part of this Covid piggy bank is drawn down over the next couple of years, consumer spending would be strong.
  • Despite the shift in expectations, interest rates in the short and long term remain below inflation.

UK public finances are improving rapidly

UK public finances are improving rapidly

Source: Columbia Threadneedle Investments and Bloomberg as at 18-Feb-22

  • Consensus expectations for the UK budget balance show a big improvement and one that should continue. On present plans it’s even possible that the UK government balance the books.
  • This reflects not just the economic recovery but also the ‘hidden’ benefits to the budget from inflation and fiscal drag.
  • This should help cool the economy and also repair the damage to government finances from Covid. But relying on politicians to do the unpopular work of slowing the economy seems unwise.
  • If governments spend rather than save their windfalls, then the burden shifts to central bankers to raise interest rates even further and faster.

What does this all mean for markets?

  • Market expectation for interest rate rises may have moved a long way, but not far enough. The economic recovery has built up a head of steam, so central banks must raise rates and the sooner the better if they are to avoid an inflationary boom/bust.
  • This is a tough background for equities, but I am still optimistic in the longer term. I am more positive on emerging markets and for value over growth style on the back of economic recovery.
  • I am much more bearish about bond yields, which are likely to out-perform only if we get a recession, which looks most unlikely to be a factor until 2023 at the earliest.
Steven Bell
Chief Economist, EMEA
Share on linkedin
Share on email
Risk disclaimer

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Views and opinions expressed by individual authors do not necessarily represent those of Columbia Threadneedle.

You might be interested in...

1 July 2024

A tough fiscal reality awaits new government

An incoming government will have to raise taxes. Politically, this is best done quickly – will courage prevail?
Watch time - 8 min
17 June 2024

Back to basics: why the time is right for a return to multi-asset

The great reset in bond yields and the prospect of inflation falling further means multi-asset is once again an attractive option for investors seeking a smoother return profile.
Watch time - 6 min
17 June 2024

Elections, interest rates and markets

A record year for elections – but what do they mean for markets?
Watch time - 6 min

Why Columbia Threadneedle for low-cost multi-asset

Columbia Threadneedle Universal MAP redefines value through active multi-asset solutions and business support at a passive price point. Fund OCFs at 0.29%-0.39%.

Our Portfolio

The Columbia Threadneedle Universal MAP and Sustainable MAP ranges offer risk-controlled portfolio options designed to cover a host of client growth, income and sustainability needs.

Important information

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

For professional investors only.

This financial promotion is issued for marketing and information purposes only by Columbia Threadneedle Investments in the UK.

The Fund is a sub fund of Columbia Threadneedle (UK) ICVC III, an open ended investment company (OEIC), registered in the UK and authorised by the Financial Conduct Authority (FCA).

English language copies of the Fund’s Prospectus, summarised investor rights, English language copies of the key investor information document (KIID) can be obtained from Columbia Threadneedle Investments, Cannon Place, 78 Cannon Street, London, EC4N 6AG, email: [email protected] or electronically at www.columbiathreadneedle.com. Please read the Prospectus before taking any investment decision.

The information provided in the marketing material does not constitute, and should not be construed as, investment advice or a recommendation to buy, sell or otherwise transact in the Funds. The manager has the right to terminate the arrangements made for marketing.

Financial promotions are issued for marketing and information purposes; in the United Kingdom by Columbia Threadneedle Management Limited, which is authorised and regulated by the Financial Conduct Authority; in the EEA by Columbia Threadneedle Netherlands B.V., which is regulated by the Dutch Authority for the Financial Markets (AFM); in Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland. In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

Thank you. You can now visit your preference centre to choose which insights you would like to receive by email.

To view and control which insights you receive from us by email, please visit your preference centre.

Play Video

CT Property Trust- Fund Manager Update

Sed ut perspiciatis unde omnis iste natus error sit voluptatem accusantium doloremque laudantium