A resurgence of inflation would hit GBP and USD, but would likely be positive for emerging market currencies closely tied to commodity prices.
Quantitative easing was designed to re-inflate economies and stimulate demand. So far the inflation impact has been muted, at least in the real economy. But there is a danger this could change.
A classic path towards inflation involves the creation of lots of new money and the first signs of inflation usually turn up in soaring stock markets, which has already happened. As confidence increases the next phases show up in the real economy.
Property markets are always a favourite as banks feel comfortable lending against this kind of asset. From there the money starts to trickle into other areas of the real economy. In the UK the property market is already very buoyant though that's not quite the case in the US. But that could change.
Gold – could inflation hedges become popular again?
The inflation cycle
Once inflation becomes well established it is widely reflected in fast rising prices of retail goods and wages.Retail prices would rise given the commodities from which consumer items are made could soar in value. Indeed, a correction in the stock market could see investors shift their money to property and commodities reigniting not only fears over inflation, but also a re-occurrence of property bubbles followed by crashes.
A particular issue for the UK and to a lesser extent the US is the amount of indebtedness of consumers and the state. The Bank of England admitted there could be limits to the scope of increasing interest rates due to high personal debts.
That would suggest that relatively high rates of inflation could be tolerated for fear of bankrupting too many borrowers. If that happened then GBP and USD would see their values steadily eroded away on forex markets. The best policy for the UK and US central banks could be to raise interest rates sooner rather than later, which should negate the need to raise them to particularly high levels.
On the other hand there are a number of significant inflation dampeners:
Banks are still scarred by the financial crisis and are having to hold higher reserves. Policy makers, even in the UK, are much more focussed on property bubbles and are more prepared to use macro-prudential tools to stop them getting out of hand.Wages in most of the developed world are under pressure due to the effects of globalisation, digitisation and the fact that companies are keen to trim workforces even when profits are rising.
Another issue are ageing populations, which could also dampen consumption and are likely to shift it more towards services and away from goods.
It's still difficult to tell if inflation will take off again, but central banks have created an enormous amount of new liquidity since the financial crisis. If economies really are normalising again all that extra money could come into play with a vengeance and create a whole new set of dilemmas for policy makers.
Recommended Content
Editors’ Picks
AUD/USD holds above 0.6500 in thin trading
The Australian Dollar managed to recover ground against its American rival after AUD/USD fell to 0.6484. The upbeat tone of Wall Street underpinned the Aussie despite broad US Dollar strength and tepid Australian data.
EUR/USD comfortable below 1.0800 lower lows at sight
The EUR/USD pair lost ground on Thursday and settled near a fresh March low of 1.0774. Strong US data and hawkish Fed speakers comments lead the way ahead of the release of the US PCE Price Index on Friday.
Gold pulls away from daily highs, holds above $2,200
Gold retreats from daily highs but holds comfortably above $2,200 in the American session on Thursday. The benchmark 10-year US Treasury bond yield stays near 4.2% after upbeat US data and makes it difficult for XAU/USD to gather further bullish momentum.
Google starts indexing Bitcoin addresses
Bitcoin address data is live on Google search results after users realized on Thursday that the tech giant started indexing Bitcoin blockchain data. However, mixed reactions have followed the tech giant's reversed stance on the cryptocurrency.
A Hollywood ending for fourth quarter GDP
The latest revisions put Q4 GDP at 3.4%, the second fastest quarterly growth rate in two years. Much of the upside was attributable to stronger consumer spending, yet fresh profits data affirmed it was a good quarter for the bottom line as well with profits up by the most since the Q2-2022.