Seven reasons why COVID-19 could lead to an inflationary regime shift – Nordea

Here are seven reasons why COVID-19 could lead to a structural shift in inflation in the Western economies, according to economists at Nordea. There are fewer deflationary risk scenarios and more inflationary risk scenarios than before the covid crisis hit.

Delta

“Supply chains are still super distressed due to high restriction levels and the ‘Zero Covid’ policy seen in particular in Asia. As far as we can judge there is no political momentum whatsoever towards scrapping the zero-tolerance policy. This likely means that supply chains will remain distressed for years ahead.”

Dignity

Dignity has been re-introduced into fiscal policy. Bailouts have been provided to practically every sector and household – in particular in the US, but also in Europe. The thing is just that covid is clearly a supply-side crisis rather than a demand shock, but politicians treat it as a demand crisis. Just about everyone will continue to receive bailouts in coming years, even if it is not needed and hence you should expect the unfunded deficits to continue for years to come. This is an inflationary game changer compared to the decade of stand-alone QE policies.”

De-globalisation

“If supply chain constraints remain a thing for years to come, it will likely also re-increase the incentives to move parts of the supply chain back closer to home soil. The lack of mobility likely also carries repercussions for labour markets where global mobility has been bombed back decades due to restriction levels and the subsequent practical obstacles of moving around.”

Dominance

“Finally workers have the upper hand against employers again, which hasn't been the case for at least a couple of decades. The quit rate as percent of employed also hints of a rapid surge in true wage growth measures such as the ESI. Wage growth is coming to a town near you this autumn.”

Disarray

“Rising prices of necessities lead to a snowball effect in political risk. Regime shifts are more likely to occur now due to rising prices, which could lead to increased disruptions in central production points.”

Dollar

“China’s attempts to reservenize the yuan may also structurally lead to less disinflation exporting by China compared to the most recent couple of decades. As China’s GDP and role in world trade continue to grow, it seems natural to expect that countries will to an increasing extent start to use the yuan as both invoicing and financing currency. And if demand for China’s currency increases, the appetite for dollars will decrease, which – keeping everything else equal – will lead to a continued de-dollarisation in global FX reserves. A process that is already slowly in the making.”

Distribution

“There are fewer deflationary risk scenarios and more inflationary risk scenarios than before the covid crisis hit. The fiscal side is back in action, meaning that both monetary policy and fiscal policy will be put into use should disinflationary forces re-enter the frame, which is a game-changer for the left-hand-side tail (deflation) of the inflation outcome space, while the potential risk of overheating and labour market-fuelled wage spirals have increased the potential amount of outcomes in the right-hand-side tail (inflation) of the outcome space. We are not certain that an inflationary regime shift has happened, but the outcome space has certainly changed compared to pre-Covid. Prepare accordingly.”