People returning to pre-COVID consumption behaviors drastically raised demand amid sluggish supply side reaction with bottlenecks
As it draws to a close, 2021 will go down in history as a year in which major economies in Europe and the US failed to cope with rising prices while their central banks acted too late against the highest inflation seen in decades.
The previous year 2020 saw an unprecedented amount of money printed due to the quarantine measures against the coronavirus pandemic. The additional liquidity was injected into the markets to prevent economies from stalling and was distributed to the public as millions were struggling with unemployment.
In the US, more than $5 trillion was printed by the administrations of Donald Trump and Joe Biden during the outbreak, while the Federal Reserve lowered interest rates to near-zero levels and started a $120 billion monthly asset purchase program.
The EU, meanwhile, introduced the Pandemic Emergency Purchase Programme (PEPP), which saw its initial €750 billion ($850 billion) envelope increased by €600 billion in June and another €500 billion in December 2020, bringing its total to €1.85 trillion.
As the lockdowns ended and economies reopened in mid-2020, people returned to their pre-pandemic consumption behaviors, drastically increasing demand.
On the supply side, however, the reopening of factories and rebooting of production lines have been slow. Due to supply chain bottlenecks, rapidly rising demand could not be met.
A global chip crisis, in addition, has been haunting the consumer electronics and automotive sectors and is expected to continue putting pressure on supply in the medium term.
The semiconductor shortage crisis affects a total of 169 industries in one way or another, according to US multinational investment bank and financial services company Goldman Sachs.
With supply shortages and rising demand in the post-pandemic period, major economies in North America and Europe have seen consumer prices and inflation hitting their highest levels in decades.
In the US, the Consumer Price Index (CPI), which measures changes in the price of goods and services from a consumer perspective, was up 1.7% in February from the same month a year ago.
This was still in the target range for the Federal Reserve, which aims for an inflation rate of 2% in the medium term.
US annual inflation, however, rose 2.6% in March, 4.2% in April, 5% in May, and 5.4% in June.
Fed Chair Jerome Powell acknowledged in July that inflation had increased notably in the US and said it would likely remain elevated in 2022 before moderating. However, he said he believed the high inflation would be “transitory.”
The CPI rose 6.2% in October, its biggest increase in 31 years, and later reached 6.8% in November, its largest 12-month increase in almost 40 years.
It was then obvious that the Fed was already behind the curve.
Powell changed his tone from dovish to hawkish before the Senate on Nov. 30, when he signaled a faster conclusion of tapering by the central bank of its $120 billion monthly asset purchases in the face of rising inflation.
Before the House of Representatives the following day, he told lawmakers that the bank was ready to use all its tools against high inflation.
At the conclusion of its two-day meeting on Dec.15, the Fed removed the word “transitory” from describing the current inflation, saying it would conclude tapering faster by doubling its asset purchases, and also signaled three rate hikes for 2022 to tame the record-high price rises.
The next day, the Bank of England (BoE) opted to take action against record inflation in a surprise move, despite a surge in cases of the omicron coronavirus variant, and decided to raise its main interest rate to 0.25% from a record low of 0.1%.
This marked the BoE’s first rate hike in more than three years, while the UK’s annual inflation increased 5.1% in November, its highest in 10 years.
Annual inflation in the EU hit 5.2% in November, while it was 4.9% in the eurozone.
The European Central Bank (ECB), however, did not make a change in interest rates but instead said the PEPP would end in March 2022.
The ECB, on the other hand, revised up its 2022 inflation forecast to 3.2% from an estimate of 1.7% made in September.
Though ECB President Christine Lagarde said there would be possible upside risk in inflation and that new coronavirus variants could be drag on growth, she said the bank expected inflation to decline during the course of 2022.
Germany’s central bank, the Bundesbank, also raised its inflation forecast, citing sharp increases in energy and commodity prices.
Inflation in Europe’s largest economy is now expected at 3.2% for 2021 and 3.6% for 2022, up from the previous estimates of 2.6% and 1.8%, respectively.
The Bank of Canada announced in October that it had ended its asset purchases and said it was on course to start raising rates earlier in 2022.
It said in early December that the average inflation rate of goods in 2021 had been 4.4% and it expects inflation to stay high during the first half of next year.
What awaits in 2022?
The new omicron coronavirus variant has brought back fears that the world and economies could undergo more lockdowns, just like in the second quarter of 2020.
Though omicron is spreading faster than the delta variant, it is believed to cause fewer hospitalizations and deaths.
Nevertheless, fear of new variants and uncertainty about the duration of high inflation are expected to make their mark next year.
It is still unclear when the supply bottlenecks will be resolved, the chip crisis will be over, and prices will start to decline.
As for those central banks, 2022 will be the year to tighten monetary policies through rate hikes and lowering money supply in order to bring inflation down to their target of 2% as fast as possible.