Insight - Inflation can get downright hot


Anticipated rise: Shoppers at a market in Kuala Lumpur. Some observers say the jump in inflation is temporary due to the base effect of low inflation last year. — Bloomberg

POST the Covid-19 economic recovery, it is generally expected that the price environment will move from deflation (reduction of the general level of prices) to inflation as economic activities and domestic demand improve amid the prevalence of spare capacity in some industries.

The standard way of discussing about inflation is to look at the state of the labour market, inflation expectations, and shocks to commodity as well as food prices.

Some argue that the jump in inflation is just temporary due to the base effect of last year’s low level of inflation when the economy was shut down, commodity and oil prices collapsed.

March’s headline inflation as measure by the Consumer Price Index (CPI) increased 1.7% year-on-year in March 2021 (0.1% in February), ending 11 months of deflation.

Bank Negara has warned that consumer inflation is anticipated to temporarily spike to above 5% in the second quarter of this year due to the extreme “lower base” effect from a deflation and low fuel prices in the corresponding quarter of 2020. The central bank now estimates headline inflation to average between 2.5% and 4.0% for 2021, a turnaround from a deflation of -1.2% in 2020.

Could prices go even higher? At 4%, policy makers may start to get worried that price increases are getting out of hand. Inflation can spike rapidly. And once inflation has taken hold, it can be painful to get price growth back under control.

Lee Heng GuieLee Heng Guie

We are definitely operating in a non-standard environment to look at largely cost-driven inflation, and a combine of the following elements not only warm up inflation, but in the months ahead, it could get downright hot, even if temporarily.

The concern is whether the spike is transitory as the central bank expects, or the start of a bigger trend ahead.

The anticipated rise in inflation goes beyond low base effect. Real price pressures have increased amid a recovering economy and consumer demand, albeit unevenly.The important drivers for the large leeway around the inflation number lies in the behaviour of the prices of oil and food as well as intermediate inputs and raw materials, which can push prices more.

Signs of inflation are already showing in the goods side of the economy.

The strong recovery in commodity prices and oil prices (the pump prices (RON95) were averaged RM1.58 per litre in April-December 2020 versus a subsidised cap price at RM2.05 per litre this year) is putting upward pressure on inflation.

Through our lenses and random checks, inflation has picked up. Some menu food prices in restaurants and food hawkers operating in coffee shops in some locations have increased prices by between 5% and 10%.

Prices of basic necessities and fresh food in markets, such as chicken, eggs and vegetables have increased due to inflation and other factors, including transport and animal feed costs.

This corroborated with the weighted CPI, which showed that “food away from home” has increased by 1.4% in March from 0.1% in January; and for “food at home” (1.6% in March), price increases were fish and seafood (+2.9); oil and fats (1.7%); fruits (1.6%); and vegetables (2.8%).

For consumer durables, the prices of furniture and mattress also increased by at least 10%. The weighted CPI for furniture, accessories, carpets household appliances have increased by 2.7% (0.9% in February) and 0.9% (0.7% in February) respectively in March 2021.

Companies have already been dealing with a range of rising prices of raw materials.

Metals, including iron and steel, and copper, have gotten more expensive.

Meanwhile, shipping costs are rising, which could affect imported goods.

Since the raw materials and intermediate inputs are purchased by manufacturers to make other goods, their rising prices put upward pressure on consumer prices if they cannot absorb the increasing costs, forcing to pass-through to consumers to preserve profit margin.

Businesses also had difficulty finding workers, which could suggest a rise in wages in addition to other costs.

Goods inflation will eventually spillover to services inflation as the economy adjusts to increased demand.

Demand will surely strengthen because households are sitting on piles of cash and savings.

The revival in consumer spending on pent-up demand should start sending prices higher like airfare, public transportation, hotels, dining out, and rental cars as more people feel comfortable leaving their homes amid a steady progress in the vaccination programme.

There could be some supply-side bottlenecks that manifest in price increases as demand rises. The productive capacity of the economy has been diminished by the pandemic. Businesses, manufacturers and suppliers have failed and exited the industry, high unemployment and workers and capital will need to be reallocated as the economy recovers.

This will further restrain supply as demand rises.

A final point to consider is the labour market condition. With unemployment rate still staying high at 4.8%, slack in labour market should restrain wage growth, which will put downward pressure on consumer prices.

Bank Negara has to keep a watchful eye on cost-push inflation for now, to anchor forward inflation expectations. This is to safeguard against the occurrence of unrelenting wage demand inflation when the workers asking for wage rise to compensate for rising cost of living.

The worrisome part is the rise in consumer inflation and the ensuing forward inflation expectations would make households jitter while the economy has not recovered firmly amid the on-going vaccination programme. This would put the central bank in a difficult bind that is to choose between taking pre-emptive step to stem a damaging surge of inflation and ensuring the benefits of the recovery to reach low-wage workers and low-income households.

Lee Heng Guie is the executive director of the Socio-Economic Research Centre. The views expressed here are his own.

Article type: metered
User Type: anonymous web
User Status:
Campaign ID: 46
Cxense type: free
User access status: 3
Join our Telegram channel to get our Evening Alerts and breaking news highlights

Insight , Lee Heng Guie , SERC , inflation , Bank Negara , CPI ,

   

Next In Business News

George Kent posts RM48.7mil profit
FBM KLCI falls 16.81 points; 784 stocks in red
Serba Dinamik denies Abu Dhabi contract is a RPT
Record net profit for Comfort Gloves
Cryptocurrencies tumble amid China crackdown on bitcoin miners
Stocks fall as hawkish Fed reverberates; Treasury yields slide
Moody’s: Chinese banks’ asset quality, capitalisation stable
Oil prices climb as Iran nuclear talks drag, summer demand aids
ESG related projects require RM45b financing in next 5 years
Iskandar Malaysia records RM7.3b investment projects completed in Jan-April

Stories You'll Enjoy


Vouchers