The Great Erosion

Christopher Dembik

Head of Macroeconomic Research

Summary:  Inflation is anything but transitory. At its March meeting, the ECB released its latest staff macroeconomic projections. All scenarios show a decrease in CPI.


Inflation is anything but transitory. At its March meeting, the European Central Bank (ECB) released its latest staff macroeconomic projections. In all scenarios, the euro area Consumer Price Index (CPI) is expected to decrease close to 2 percent year on year in 2023 (see Chart 1). This is wishful thinking; it currently stands at 5.8 percent year on year (the latest figure for February). It’s not just oil and energy prices that are rising fast anymore. Food, non-energy industrial goods and services are all accelerating at more than 2 percent; inflation is now broad-based. This is before we see the full consequences of the Ukraine war on the inflation dynamics. Our baseline is that the war will add at least one percentage point to the average euro area CPI this year. We have discovered with the conflict that Ukraine is a hub of international trade; for instance, it produces 70 percent of global neon gas exports. This purified version of gas is crucial to the semiconductor industry and we need it for many daily life products such as smartphones, medical devices and household appliances. But war is not the only issue on the table. 

Supply chains disruptions will last at least until 2023 

Supply chain disruptions are increasing. There was no real improvement before the war and now, things are getting worse; this is the biggest trend unfolding in front of us. On top of closed and sanctioned Russian mineral exports, several countries are limiting their exports of basic goods. On March 14, Argentina shut down its soya and soy oil exports (41 percent and 48 percent of global exports respectively) for an unlimited period. At the same time, Indonesia tightened export curbs on palm oil—the world’s most widely used vegetable oil and used in several food products. Many countries are following the same path, including Serbia, Ukraine, Egypt, Algeria and Bulgaria. Others are still dealing with the pandemic. Shenzhen, China’s enormous manufacturing hub and port city, went into lockdown in mid-March. Shenzhen is home to some of China’s most prominent companies, including Tencent Holding, operator of the popular WeChat message service, and the electric car brand BYD Auto. It’s also the fourth largest port in the world by volume with the transit of 15 percent of Chinese exports. It could take six to eight weeks to clear the backlog; a sustained improvement in international shipping is only expected in 2023 onwards when new containers will arrive in the market. Port congestion is not the only driver of inflationary pressures. In the past few months, we have mentioned several times that the European green transition is fundamentally an inflationary shock for the European households and companies (see our Q1 outlook).  Instead of the COP26 resulting in a phasing down of coal, the sad reality is that coal and gas are growing. Hopefully, the Ukraine war will lead to a rethink of the Germany and Belgium nuclear phase-out, but it will take at least 7 to 10 years before new nuclear power stations are operational. In the interim, inflation will remain a headache. 

History doesn't repeat itself, but it rhymes 

In our view, comparing today’s inflation with the 1970s or the 1973 oil crisis does not make sense. There are at least two main differences: the Covid-19 policy mix in the developed world was out of all proportion to what we have known in the past, and there’s no price-wage loop in most euro area countries. In the 1970s, wages were automatically indexed to inflation. This is not the case anymore, with a few exceptions (in Cyprus, Malta, Luxemburg and Belgium, indexation is based on core CPI). So far, wage negotiations in euro area countries have led to an average increase below inflation (less than 1 percent in Italy and between 2 and 3 percent in the Netherlands, Austria and Germany, for instance); this is not the stagflation we experienced in the 1970s. Some economists call this new period the Lowflation. We call it the Great Erosion: erosion of purchasing power, corporate margins and growth due to the explosion of supply costs at the global level. This is the fifth regime shift over the past twenty years: the Great Moderation, the housing bubble, the Secular Stagnation and the Taper Tantrum were the other four. The main question now is who will bear most of the cost. Our bet? Corporate margins. What could prevent this? Basically, we need productivity gains. Unfortunately, we don’t see strong evidence in the data of sustained productivity gains from remote work, and whether the green transition will have a net positive or negative effect on productivity is debatable. 

The inflation/recession dilemma 

All the central banks are officially committed to fighting inflation—this is obvious. The hawks clearly took control of the ECB narrative at the March meeting, but some central banks are certainly more committed than others. We suspect they could take a sustained 3-4 percent annual inflation rate rather than engineering a recession to get them lower. This means they could bluff about it staying hawkish in words rather than deeds. This is certainly more the case for the US Federal Reserve than for the ECB. Don’t forget inflation above the last 20-year average has a positive impact on the debt burden too; this is an added bonus. After the Global Financial Crisis of 2007-08, many countries tried the conventional way to reduce debt—meaning austerity and structural reform. It has failed and now it’s time to adopt a more unconventional approach: inflation, repression and, in a few cases, default. This will have major implications in terms of investment (outweigh commodities and real estate amongst other options) but also fiscal policy with increased income redistribution for the lowest quintile of households. Not everyone is prepared for what is coming: a prolonged period of high inflation before it drops. 

Quarterly Outlook

01 /

  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.