The entire world, especially the Western economies are grappling with high inflation rates. DWS debunks various myths surrounding inflation and takes a closer look at its drivers. The asset manager also explains its predictions about the future trajectory of inflation.

Looking at the U.S. and Eurozone, DWS firmly believes that the central banks would maintain their 2% inflation target to maintain their credibility. However, achieving this target could take longer due to the impact of the pandemic on labour market, the rise in wages, and the resulting demand, says the asset manager. This implies that the inflation rates will decline slowly.

DWS further disagrees with the common notion that banks would miss their inflation targets in the long term due to the four structural drivers, the 4 Ds – demographics, decarbonisation, digitalisation and deglobalisation. Björn Jesch, Global Chief Investment Officer of DWS states, “First, the impact of these drivers seems to be overestimated; in some cases, it is not even clear whether the correlation is positive or negative. Second, these drivers only explain why individual (relative) prices have to change. They do not explain why all prices – the inflation index as a whole – should rise faster than in the past.” Monetary policies, and not these structural factors, have the power to contain inflation, clarifies the asset manager.

Talking more about the four structural factors, DWS states decarbonisation and deglobalisation are ‘clearly’ inflationary. Climate change is making it necessary to adapt production in many respects, and companies can pass on the associated costs in the form of price increases. However, the impact of decarbonisation is limited to a few relative prices. Similarly, the extent of deglobalisation and its impact on inflation is likely to be rather small. But the asset manager says there isn’t enough empirical evidence to prove that demographics and digitalisation are inflationary.

Another factor that plays a critical role in the central banks’ interest rate decision is the level of government debt. This is also known as ‘fiscal dominance’ or ‘financial dominance’. If the government debt is too large, the central banks may not be able to raise the interest rates otherwise nations could go bust. But DWS clarifies that a central bank has more than one monetary policy tool to contain inflation. Jesch says, “Interest rate hikes generally have an asynchronous effect: They arrive quickly in the financial and insurance sector but only begin to brake the economy as a whole after some delay.”

On a realistic note, DWS confirms that the various roadblocks due to the national debt, climate targets, and supply-side issues related to the pandemic, or the Ukraine war will make it difficult for the central banks to achieve the 2% inflation target. “Average inflation rates of 2.5% in coming years look quite realistic. But we believe the central banks will not be satisfied with inflation rates of 3 to 4% in the long run.”

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