How much should we fear inflation?

Hopes are running high that the strengthening global economy could start to pull clear of the pandemic. But the promising news also comes with a potential health warning: inflation. How much is Switzerland at risk?

Companies all over the world and across the board – from car manufacturers to food producers and computer makers – have sounded the warning bell over the rapidly increasing cost of raw materials.

A global shortage of computer chips has raised fears that electronic goods could start to cost more. The problem has been made worse by a shortage of container ships to transport goods around the world.

The issue is not confined to big business. The worry is that rising prices could soon start to hit people in the pocket when they buy everyday items, such as furniture.

“There are products that are up to 50% more expensive than they were two months ago,” says Peter Baumann, owner of the small carpentry business, Freba, in northeastern Switzerland. He cites different types of wood and a range of fittings such as handles and hinges.

Inflation “temporary”

Worse still is that the supply of purchased materials has become erratic, with shipments turning up late and incomplete. The company has been forced to warn customers that cost and time-scale estimates for work may be subject to change.

“The worst-case scenario would be to have full order books without being able to get materials. This is what you call entrepreneurial risk,” says Baumann. The small business owner must now figure out how much of the cost to pass on to consumers without being undercut by competitors.

A similar message is being repeated across the board. Food producing giant Nestlé and engineering association Swissmem are among the bigger, internationally facing groups that have recently complained of a surge in raw material prices.

Economists and central bankers are starting to take notice of the perils of inflation. Higher oil prices “are likely to bring about a temporary rise in global inflation this year,” said Swiss National Bank (SNB) chairman Thomas Jordan on June 16.

“If [consumer] demand develops strongly, this could lead to capacity bottlenecks and drive up inflation,” the State Secretariat for Economic Affairs (Seco) stated in its latest forecast in the same week. But both the SNB and Seco still forecast a moderate Swiss inflation rate of 0.4% this year, which is broadly in line with other predictions. The SNB has decided to keep interest rates at a rock-bottom -0.75%.

Fears “exaggerated”

This looks somewhat contradictory. So what is the explanation? Economists admit the potential danger of inflation exists, but judge the actual risk to be small. Jordan expects prices to rise for another few months, while  SNB forecasters “do not anticipate a strong increase in global inflation in the medium term.”

Sustained inflation requires a sustainable increase in business activity and consumer spending. New waves of Covid-19 variants are likely to create enough uncertainty to hold that in check for a while longer.

In this climate, companies will be reluctant to ramp up production. Consumers may be taking advantage of re-opened shops in some countries, but many still have job security concerns.  

“I believe that inflation fears are a bit exaggerated,” Jan-Egbert Sturm, head of the KOF Swiss Economic Institute, told SWI swissinfo.

Raw material prices (oil, gas, minerals etc) are simply rebounding from a deep recession caused by the pandemic, Sturm points out. Oil prices may have tripled in the last few months, but the commodity is now trading at roughly the same price as just before the pandemic.

Producers of raw materials have been taken surprise by the speed and scale of increased demand, particularly in China and the US. It won’t take too long before normality returns to production and supply chains, he argues.

Central bank spending

Inflation of below 2% is seen by economists as a positive sign of growth. Concerns are triggered when the price of goods, combined with wage increases, overheats in an unsustainable manner. There are no current signs of overheating in the Swiss economy, contends Sturm.

Another potential driver of inflation is the amount of money that the SNB and other central banks are pumping into the system whilst keeping interest rates low. The SNB’s balance sheet has swollen to nearly a trillion francs, doubling in size in the last seven years.

Most of this has been spent on foreign bonds and equities to keep the franc from appreciating too steeply against other currencies. Despite slowing the franc’s appreciation, the safe haven currency “remains highly valued”, according to Thomas Jordan.

In an interview with the Neue Zürcher Zeitung newspaper in May, Jordan said that the relative strength of the franc should help stave off inflation in Switzerland. This is because imports are cheaper when the franc is strong.

Jordan also pointed out that Switzerland’s national debt burden is much lower than in other countries, meaning there would be less political pressure on the SNB should it need to raise interest rates to stave off inflation.

Juggling act

But should inflation become a problem, the SNB would be left between a rock and a hard place. Increasing interest rates and restricting currency supply would help calm inflation but it would also heighten the risk of the franc appreciating.

“The task of central banks hasn’t become easier in the new world in which we are not simply talking about interest rates, but we’re also having to manage these huge amounts of liquidity,” said Sturm. “That makes things more difficult. Monetary policy has to be handled with great care and probably cannot be implemented as swiftly as in the past.”

But Sturm has confidence that the SNB will manage to pull off this juggling act should it be required.

As for interest rates: “Market participants still do not expect central banks to begin raising interest rates until 2023,” said SNB board member Andréa Maechler at the latest monetary policy briefing on June 16.