(Bloomberg) — The Western world can expect to live with inflation running between 4% and 5% for years, and sharply lower asset prices as a result, according to Pascal Blanque, chairman of the Amundi Institute.
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The new environment comes as policy makers balk at the risks to growth needed to quash decades-high price growth, said Blanque, a former chief investment officer of Amundi SA. Central banks will end up prioritizing nominal growth and “tolerating” higher inflation with relatively low real-interest rates, he said.
This adjustment to higher-for-longer inflation, following a decade where US headline inflation averaged 2%, will involve a complete rethink in valuations from the equilibrium price-to-earning ratios in stock markets to the level of bond yields, according to Blanque. The 12-month trailing price-to-earnings ratio of the S&P 500 is approximately 13% above where it was during historical periods of 3% to 6% inflation, according to Amundi Institute calculations.
“We will see more noise in terms of the volatility of inflation itself, which will lead some people to think that the beast is dead or retreating — which may prove to be a trap,” Blanque said in an interview. He served as the CIO of Europe’s biggest asset manager for more than a decade before joining its research arm in February.
Pricing In Success
The Federal Reserve has already delivered the fastest pace of tightening since the early 1980s in two consecutive 75-basis-point rate rises, while the European Central Bank abandoned forward guidance at its last rate decision in a surprise 50-basis-point hike. Yet these actions are not the “abrupt policy regime shift” needed to bring inflation to target, Blanque said.
“Markets are already pricing to some extent the fact that inflation will be under control due to the action of the authorities and, due to some luck, inflation retreating on its own,” Blanque said. “The market has priced in the success of the battle before it has really started.”
Central banks have benefited from the role of China and Asia in helping keep inflationary forces in the world economy at bay, he said. But the decades of easy monetary and fiscal policy in response, from quantitative easing to expansive spending policies by governments, has instilled a belief in markets that policy will always be accommodative.
That’s making it harder to tighten financial conditions enough to damp price pressures. “You’ve got to convince the markets and economies that you are serious about turning the corner in terms of tightening,” he said. “That’s probably where the credibility challenge lies.”
Since reaching a peak in June, financial conditions in the US and the euro area have actually loosened, according to Goldman Sachs gauges. Expectations that inflation may be quashed have started to take hold, with a looming recession in Europe giving way to the idea that a crunch in consumption could help bring inflation down. Meanwhile, a cooler-than-expected US inflation print for July gave rise to hopes that central bank officials may find evidence to slow their tightening.
“At the end of the day there is likely to be a compromise in the policy mix where monetary policy will stop one way or the other below neutrality,” said Blanque. “That means tolerating a higher trend of inflation and this is what is not fully priced in the markets.”
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