Spark Global Limited reports:
Housing and wages: The relationship between Inflation
While stubbornly high inflation is largely caused by supply chain disruptions, which will eventually abate in 2022, two other important factors need to be monitored, namely rising housing costs and wages, as these conditions are likely to be stickier.
Housing costs account for a large part of the inflation basket in most countries, although methods vary. During the pandemic, house prices in many developed countries rose at an unusually high rate, fuelling inflation. In the US, rent costs are catching up. With housing costs accounting for as much as 40 per cent of the US consumer price index, inflation is likely to be at least a key source of upward pressure over the coming year.
As for wages, given that seven out of the last eight US CPI data have exceeded consensus expectations, the risk, in our view, is that higher inflation filters into wages and could create a wage-price spiral that would require central banks to suddenly rein in monetary stimulus, which could choke off the recovery and trigger financial market volatility.Wage pressures are already evident in America and Britain. In the former, average hourly earnings rose 4.9 per cent year on year in October, but this still represents negative real wage growth given higher inflation. In the UK, total wages rose 5.8 per cent year-on-year in the July-September period. In contrast, average hourly earnings in Canada rose just 2.0 per cent year on year, and average hourly earnings in the European Union remained low.
The upward pressure on wages comes from labor shortages, which allow workers to demand higher wages. About 3 million workers in the US have opted for early retirement as migration from developed countries has been hampered by COVID-19, the Federal Reserve said. The Labour shortage has been exacerbated by the expulsion of EU workers after Brexit. Some countries have also raised minimum wages.
The Bank of Canada and the Bank of England are expected to be the most aggressive in raising rates over the next 12 months, with as many as five hikes expected by the end of 2022, reflected in forward market expectations.
Chinese banks have been aggressively scaling back their COVID-19 stimulus. Given strong economic growth, high COVID-19 vaccination rates, and strong job growth, the central bank recently reduced its asset purchases to only reinvestment, effectively ending its quantitative easing program. Bank of Canada Governor Tiff Macklem and his colleagues suggested rates could rise as early as April 2022. Inflation rose 4.7% in October from a year earlier, which we believe the central bank is likely to see as vindicating its stance.
In the UK, the Bank of England has recently emphasised that a modest tightening of monetary policy may be necessary to meet its 2 per cent inflation target. Prices surged in October, with the CPI hitting 4.2%, the highest level since 2018. Before raising rates, the boe had been waiting to see how the termination of its employment support scheme in September would affect the Labour market, but with unemployment continuing to fall and wage growth strong, the chances of a December rate rise have increased. Markets are pricing in two more rate hikes in 2022.
In the US, higher and more persistent inflation could mean a shift in expectations. Can the current $15bn monthly reduction be accelerated to $20bn a month? When and by how much will interest rates rise?
We continue to expect the Fed to keep tapering at $15 billion as markets like consistency. With tapering likely to end in mid-2022, we expect the Fed to review conditions at that time and bring the unemployment rate below 4% before raising rates. We expect to raise rates once in late 2022, although we acknowledge that another hike is possible in 2022 if inflation remains high.