COVID-19's impact on inflation

Despite upward price pressures in certain industries, on balance there doesn't appear to be a sustained inflation dynamic at work.

Temporal supply/demand mismatch

Thus far, the Covid-19 pandemic has had a negative impact on both demand and supply. Initially, the fall in demand was disinflationary, particularly via lower energy prices and most affecting those industries directly linked to the velocity of people such as airlines, hotels, autos and clothing. For example, in the US these four categories, which represent only 8% of the CPI basket, together dragged headline inflation lower by a full percentage point between February and June. However, demand has rebounded forcefully and is beginning to highlight some supply-side pressures, in particular in those areas which have seen heightened demand over the lockdown period. Where in place, furloughs or short-term working schemes are essentially paying citizens not to produce. One way to measure this is via supplier delivery times, which have bounced back rapidly from the lows. This points to a normalisation in inflation into 2021. Moreover, we believe the sharp reduction in energy prices earlier this year will drop out of the year-over-year headline figures around the same time next year, as the above factors potentially amplify this impact.

Exhibit 1: Advanced Economies—Core CPI

Source: Haver Analytics, JPMorgan/IHS Markit. As of 30 Jun 20.

However, this temporary bottleneck should normalise as supply catches up, supply chain pressures ease, and the ongoing demand rebound likely flattens due to ongoing and new mobility restrictions as well as increasing uncertainty about future job support. But it does mean that the likely low point in inflation will not be as low as many initially expected. As a result, this has supported inflation-related asset prices.

Consumption patterns

Changed consumption patterns, which for example have resulted in higher demand for used vehicles (to substitute for public transportation), generic healthcare and home improvement-related goods are beginning to gain in price. If this increased demand lasts, the consumer basket will begin to reflect this over time via higher weights. Correspondingly the sector weights that are most exposed to the velocity of people will likewise fall and this is where the disinflationary pressures have been keenest. Additionally, this has added to the ongoing demographic trend of a rising basket weight for healthcare, which typically sees a higher-than-average inflation rate.

Covid-related costs for business

Fixed costs for some businesses are rising due to Covid, given the expenses incurred by restaurants and offices to comply with new spacing requirements for social distancing, employee health screenings, physical partitions and deep cleaning. In most instances these costs will not be passed on to consumers. However, in areas where demand is inelastic, such as healthcare, these costs do appear to get passed on.

Government policies

Some countries have reduced VAT rates to spur consumption. If passed through to consumers, this will have a negative impact on headline inflation over the subsequent 12 months. Other ‘consumption-inducing’ policies will have a similar effect. For example, in the UK, the ‘Eat out to help out’ discounted restaurant meals will likely shave around 40-50 bps off headline inflation in the upcoming August print. Near-term inflation will be negatively impacted should these types of schemes become more widespread.

E-commerce

Here the virus has acted as an accelerant to a trend that has been in place for the last 15 years, namely the rising share of online retail sales. In particular the older age cohorts, who have previously had a much lower online presence compared to younger age cohorts, are now shopping online more frequently. Exhibit 2 shows e-commerce as a percentage of total retail sales in the UK. This has been a key disinflationary pressure that over the near term will exert a stronger disinflationary effect going forward. Japan is an extreme example of the boom in e-commerce, with credit card companies forecasting that they will shortly run out of 16-digit credit card numbers due to the surge in online shopping during the lockdown period.

Exhibit 2: Great Britain—Internet Sales as a Percentage of Total Retail Sales

Source: Office for National Statistics/Haver Analytics. As of 30 Jun 20. 

Recent inflation surprises

Recent inflation prints have surprised to the upside. However, a lot of this has been related to those four categories mentioned above: airlines, hotels, autos and clothing. For example, the typical seasonal pattern for clothing prices in the eurozone has been thrown out of kilter. Prices fell sharply in March and April, when prices are typically stable, yet prices were not reduced in June or July around the start of the summer sales period, leading to much higher inflation rates than expected. These seasonal distortions will wash out next month, pushing inflation lower.

Our inflation outlook

We continue to closely monitor the evolution of the pandemic and look for bottom-up signs that may challenge our top-down economic view that inflation will rebound from the crisis lows but that inflation generation remains challenged over the longer term. On balance, we don’t think we have found enough evidence of a sustained upside inflation dynamic. For now, we remain overweight inflation as long as the market still prices an even more pessimistic scenario, but we have reduced our overweight modestly as valuations have moved closer to our view on the back of recent upside prints.

For more articles, please visit our insights page


Definitions

The Consumer Price Index (CPI) measures the average change in U.S. consumer prices over time in a fixed market basket of goods and services determined by the U.S. Bureau of Labor Statistics.

One basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

value added tax (VAT) is a type of consumption tax that is placed on a product whenever value is added at a stage of production and at final sale.

Purchasing Managers Indexes (PMI) measure the manufacturing and services sector activity in an economy, based on survey data collected from a representative panel of manufacturing and services firms. A PMI number greater than 50 indicates economic expansion; below 50, contraction.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.


About the author

Richard Booth is a Portfolio Manager and Research Analyst and has been with Western Asset since 1999. He has 21 years of industry experience. As a member of the Global Inflation-Linked Team, he is responsible for the day-to-day portfolio management of global inflation-linked portfolios alongside the development and implementation of global inflation-linked investment strategy. Before joining the Firm, he was a Research Analyst at Foreign & Colonial Asset Management.

Mr. Booth holds a Bachelor of Social Science degree in Money Banking and Finance from Birmingham University.


Important Information

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.


The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.

This material is only for distribution in those countries and to those recipients listed.

All investors and eligible counterparties in EU and EEA countries:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office Floor 6, Building Three, Number One, Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4. D04 EP27, Ireland. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

In the UK, this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the UK Financial Conduct Authority.

In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH.

Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People’s Republic of China (“PRC”):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (109) Jin Guan Tou Gu Xin Zi Di 016; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

The aforementioned Legg Mason entities are wholly owned subsidiaries of Franklin Resources, Inc.


The information, materials or opinions contained on this website are for general information purposes only and are not intended to constitute legal or other professional advice and should not be relied on treated as a substitute for specific advice of any kind.

We make no warranties, representatives or undertakings about any of the content of this website (including without limitation any representations as to the quality, accuracy, completeness or fitness of any particular purpose of such content, or in relation to any content of articles provided by third parties and displayed on this website or any website referred to or accessed by hyperlinks through this website.

Although we make reasonable efforts to update the information on this site, we make no representation warranties or guarantees whether express or implied that the content on our site is accurate complete or up to date.

Be the first to hear news and insights from Embark Group

Sign up to receive updates from Embark Group and its businesses. You can unsubscribe at any time using the link at the bottom of our emails, and we promise never to pass your details to a third party. Please consult our Privacy Notice for more information.

  • This field is for validation purposes and should be left unchanged.