skip navigation

Blog

Stay up to date on timely topics and market events. Subscribe to our Blog now.

ECONOMY
September 03, 2020

The Impact of COVID-19 on Inflation

By Richard A. Booth

Stay up to date on timely topics and market events. Subscribe to our Blog now.

Following up on our blog post about the long-term structural drivers of our inflation view, this post explores some of the shorter-term impacts to inflation due to the Covid crisis.

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 normalization in inflation into 2021. Moreover, 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
Explore Advanced Economies—Core CPI.
Source: Haver Analytics, JPMorgan/IHS Markit. As of 30 Jun 20. Select the image to expand the view.

However, this temporary bottleneck will normalize 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
Explore Great Britain—Internet Sales as a Percentage of Total Retail Sales.
Source: Office for National Statistics/Haver Analytics. As of 30 Jun 20. Select the image to expand the view.

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.

© Western Asset Management Company, LLC 2021. This publication is the property of Western Asset and is intended for the sole use of its clients, consultants, and other intended recipients. It should not be forwarded to any other person. Contents herein should be treated as confidential and proprietary information. This material may not be reproduced or used in any form or medium without express written permission.
Past results are not indicative of future investment results. This publication is for informational purposes only and reflects the current opinions of Western Asset. Information contained herein is believed to be accurate, but cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Western Asset may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of residence.
Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorised and regulated by Comissão de Valores Mobiliários and Banco Central do Brasil. Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services Licence 303160. Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services Licence for fund management and regulated by the Monetary Authority of Singapore. Western Asset Management Company Ltd is a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan. Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority (“FCA”). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK and EEA countries as defined by the FCA or MiFID II rules.