Expect a Return to Inflation – But Not as We Once Knew Itby and
Innovation in retail sector poses new headwind for inflation
Could ease pressure on central banks to accelerate tightening
Across the world, a nascent recovery for inflation has stirred optimism that after years of soggy demand, prices may finally be gaining escape velocity.
A dose of inflation, within reason, helps economies grow by boosting company profits -- with textbooks telling us wages should follow -- and makes debt easier to service (at least until interest rates rise). The latest reflation burst was sparked last year by a big turnaround in Chinese factory prices and an improving outlook for global growth.
But this may not herald a return to inflation as we once knew it. Unlike previous cycles when prices accelerated and policy makers had to step in and cool demand, a damper this time around is the dizzying pace of innovations in the retail sector.
The rise of online shopping and price comparison websites has hooked consumers on discounts. And even when people tear themselves from their screens and actually make it to the shops, fewer staff and less glitzy stores are keeping prices down there too.
It’s a development that economists at an Australian bank have dubbed the “Aldi-isation effect” after the German discount supermarket known for its no-frills approach.
“The cutting edge of retail will continue to increase price competition and thus carry a deflationary drag,” said Richard Yetsenga, who is the Sydney-based chief economist at Australia & New Zealand Banking Group Ltd. “The ‘Aldi-isation’ trend is here to stay.”
The 2017 Total Retail report from PricewaterhouseCoopers LLP found that 47 percent of the 24,471 respondents surveyed across the globe use Amazon.com as a research site for prices. Japan, Germany, Brazil and the U.S. were found to be the top four countries where consumers shop less often at brick-and-mortar stores due to the "Amazon effect."
“Competition has never been fiercer,” said John Maxwell, global retail & consumer leader at the consultancy.
The results can be seen around the world. In the U.S., the consumer price index for apparel has been going nowhere, as the chart below illustrates:
Discounting is probably playing a role in holding down retail wages too, at least in the U.S. where the retail category shows the smallest 12-month wage gain of all sectors tracked in the monthly U.S. employment report, according to NatWest Markets.
Japan’s central bank is desperately trying to stoke inflation, warning last month that cheap mobile phone handsets and connection fees are weighing on the consumer price index. The bank attributed this to intensified competition from virtual network operators.
Investors have been scaling back their optimism on inflation picking up since the start of the year. The global bond market measures price-growth expectations through breakeven rates, which is the yield spread between sovereign debt and inflation-protected securities with a similar maturity. While still up from year ago levels, breakeven rates in Group of Seven countries have fallen from peaks earlier in 2017.
In the U.S., the 10-year breakeven rate is about 1.9 percentage points, down from a 2017-high of 2.09 percentage points in January. It’s 1.16 percentage points in Germany and 0.46 percentage points in Japan, both down from earlier this year.
Jack Ma, Chairman of Alibaba Group Holding Ltd., has warned of decades of pain as the Internet disrupts economies. China’s consumer prices climbed 1.2 percent in April, less than half the government’s target of around 3 percent, even as data from the nation’s dominant bank card network and No. 2 e-commerce platform JD.com Inc show consumption remains buoyant.
Aldi is planning its biggest remodeling investment ever in the U.S. in a bid to steal market share from big supermarket chains. At the same time, Wal-Mart Stores Inc. is ramping up its e-commerce operations. The American retail industry started off the year closing brick-and-mortar stores at a record pace, according to Credit Suisse estimates.
“I can’t remember any retailer I’ve talked to who is counting on inflation helping them out,” said Erik Gordon, a professor at the Ross School of Business at the University of Michigan in Ann Arbor, who has been covering retail trends for almost 30 years. “They’re all looking for ways to cut costs, because they’re expecting it to get worse. They’re not expecting it to get better.”
To be sure, competition among retailers isn’t new and the picture for inflation globally varies regionally and is impacted by a number of forces.
Volatile food and energy prices are crucial swing factors, especially in emerging markets. On the supply side, prices for manufactured goods aren’t going anywhere fast as the next generation of cheap labor economies nip at China’s heels and robots replace workers in economies with higher labor costs, allowing them to become competitive again.
Developed nations have for years flirted with deflation for reasons that had less to do with online shopping and more to do with tepid underlying economies, which are grayer and aren’t enjoying the fruits of a burgeoning consumer class.
Restrained credit growth from companies and consumers still scarred by the crisis has also damped demand. That means less cash is chasing goods and services in the real economy -- which tells you all you need to know about today’s subdued prices according to monetarist orthodoxy.
And that’s where reflationists see things turning around. The world’s biggest central banks are continuing easy policies, while China’s shift from factory deflation to rising prices could start to be shipped around the world as exporters there increase asking prices.
Still, the importance of consumption -- it accounted for 58 percent of global GDP in 2015 according to the World Bank -- means sweeping changes in shopping patterns will act as a restraint on the pace of inflation and could be a factor determining how quickly central banks tighten should global growth continue to perk up.
The International Monetary Fund is projecting average inflation in the G-7 will be sub-2 percent in the medium-term horizon. While that’s better than the sub-1 percent inflation in 2015 and 2016, it’s below most central bank inflation targets.
Back in Australia, more competition is on the way with Amazon.com Inc due to expand operations in the country this year.
“We are expecting a general global trend to higher interest rates over the next couple of years,” said Yetsenga. “But Aldi-isation suggests the move will be slow.”