Will the coronavirus crash lead to a double digit inflation spike?

Will the coronavirus crash ultimately lead to a huge spike in inflation?

With consumer prices inflation having plunged to 0.8 per cent in April, you could be forgiven for thinking a suggestion of a return to the bad old days of high inflation is wrongheaded.

And it’s certainly true that pressing the pause button on consumer economies around the world is going to be deflationary in the short term.

Yesterday’s ONS figures showed the inflation rate almost halved from 1.5 per cent in March, largely driven by a dramatic slump in petrol prices and energy costs.

The dive in CPI is likely to continue and we could even see it go negative, bringing deflation.

Set against that it is easy to understand why there seems to be little concern that a colossal wave of money printing by central banks, such as the Bank of England and US Federal Reserve, and the spectacular bout of largesse by governments will be inflationary.

In contrast, as I wrote in this column a few weeks ago, there is an outlier idea gaining traction that central banks could simply print the money to buy the government debt needed to fund rescue schemes.

Rather than impose tax rises and spending cuts that will hamper their economies for years to come, this would effectively allow governments to write off the cost of the great coronavirus rescue.

Wouldn’t this be highly inflationary?

‘No,’ say proponents. To heavily simplify their argument, they suggest the inflationary effect of all that printed money will be nullified by the deflationary effect of the coronavirus measures.

It’s as if lockdown created a giant deflationary economic pothole and the printed money just fills it.

There is another side to the argument, however, as we feature today from Pete Comley, the author of the book Inflation Matters, who along with some others says a wave of inflation will be the ultimate result.

I don’t know which end of this debate is right, but I do think it’s worth listening to both sides.

Pete puts forward the case that the coronavirus lockdowns will be deflationary in the short-term, but that the effects of quantitative easing money-printing will be different to the financial crisis era.

Pete says: ‘The extra money created in the 2009 Quantitative Easing mainly repaired bank balance sheets and did not reach the man in the street and so did not affect consumer prices much.

‘In contrast, the new money today is being injected directly into the real economy and will be inflationary.’

The problem we will then face is that central banks and governments will go easy on inflation, which risks it spiralling.

In the absence of any appetite for widespread tax rises, or another dose of austerity, the government and Bank of England will indulge in financial repression to erode the value of the debts built up.

This involves allowing inflation to run above interest rates and means that the value of the extra borrowed money gets whittled away.

In Britain, our big mortgages and sizeable personal debt pile, provide another reason for not wanting to increase interest rates by much.

Pete says: ‘The UK government is likely to allow inflation to rise and will use it as a form of “inflation tax”.

‘There is a precedent for this. Historically, governments have not paid back borrowing created in national emergencies. Instead they have used inflation to reduce the value of a country’s debts in real terms and to make interest repayments more affordable.

‘They are also likely to hold base rates near zero for a long time to reduce their interest payments.’

He forecasts that inflation could even return to near double-digit levels towards the end of this decade, before a 140-year long inflationary wave breaks and a price crash follows.

Setting what a price crash could mean for us to one side, even the return of 5 to 10 per cent inflation over a prolonged period would seriously shake up our personal finances.

There is a big chunk of the working population for whom this is not something they have experienced in their adult life – yours truly included.

Our parents’ generation lived through the high inflation and high interest rate years and regularly warn us that it wasn’t much fun.

Yet, at least wages rose at a fair clip back then. Whereas, in today’s corporate world low wage growth is firmly entrenched and workers’ bargaining power is greatly reduced.

There’s a strong possibility that even if inflation rose to 7 per cent, wage rises would remain stuck at 3 per cent.

An inflationary spike could also cause a major headache for investors.

Bonds are the ‘safe’ part of their portfolios and have remarkably proved much safer than most thought they would as crisis hit again.

They won’t be your friend if inflation spikes, however, leading the interest rate returns on existing bonds looking very unattractive and causing prices to slump.

Pete points out that shares will be the thing to invest in, but adds that high inflation will cause companies problems and also shave a lot off ‘real’ after-inflation returns from investing in the stock market.

This is not to say that any of this will happen. Warnings of the return of inflation have proved unfounded repeatedly over the past couple of decades.

It’s an argument worth considering though.