LUXEMBOURG
DAVID SEBAN-JEANTET

Developed economies have faced a continuing decline in their inflation levels in recent years, coupled with weak economic recovery. This has led to fears of a possible period of “secular stagnation” as low inflation often goes hand in hand with sluggish economic growth.

Lack of inflation also contributes to rising inequalities as inflation generally has an erosive effect on the purchasing power of capital, thereby allowing for a better redistribution of wealth.

However, 2017 should be characterized by a structural change where developed economies should manage to transition from this long period of disinflation to an era of gradual recovery in inflation. This new trend is reinforced by the election of Donald Trump and the new “Policy Mix” of his administration.

What are the main causes of inflation ?

The “monetarist” school of macroeconomic thought, influenced by Irving Fisher’s work, has defined inflation as being primarily a monetary phenomenon, establishing a direct relationship between the inflation rate and money supply growth.

In this perspective, quantitative easing policies such as the ones implemented by the Federal Reserve or the European Central Bank should have rekindled inflation. These policies have however failed to bring inflation close to the 2% target set by most Central Banks in developed economies.

In this case, the monetary theory does not seem to solve the inflation conundrum. It is therefore necessary to delve deeper and to look at inflation from another angle. The Keynesian view is that inflation is a phenomenon in and of itself, generated by high demand, a drop in supply or higher labor costs.

The unusually low level of inflation experienced in the past years can indeed be attributed to weak demand and the resulting excess supply. The advent of the digital economy and e-commerce has reduced barriers to entry, allowing for increased price competition, which translates into lower inflation.

Beyond this structural explanation, the decline in inflation has also been induced by a cyclical factor, namely the collapse in commodity prices seen since 2014. In particular, oil price has decreased from over 100 $ per barrel in August 2014 to less than 30 $ per barrel at the start of 2016, preventing consumer prices from growing significantly in 2015 and 2016.

Towards a progressive recovery in inflation

There have been signs pointing to a recovery of inflation since the start of the year, which should bring some peace of mind to investors and economists alike.

On the macro front, fiscal stimulus is expected to replace years of expansive monetary policies as the new US administration should invest massively in infrastructures while lowering tax rates. Combined with the fact that the US has almost reached full employment, this is poised to generate surges in inflation. This policy will be accompanied by a certain degree of protectionism which will constitute an obstacle to the free formation of prices. Other countries such as Japan are also following similar paths.

On the commodities front, OPEC-member countries have reached an agreement to limit production, which will reduce the supply-demand imbalance in the oil market and will support higher prices.

Finally, the ability of commercial banks to increase their credit supply should improve, after years of having been constrained by ever heavier prudential standards.

It therefore appears that inflation is poised to rebound and approach the Central Bank’s target for the Euro zone. A pick-up in inflation expectations lays the foundations for a more vigorous economic recovery and a better redistribution of wealth. Investors will of course need to adapt their asset allocation to this changing environment.

Societe Generale Bank & Trust

OLDEST FOREIGN BANK IN LUXEMBOURG

Established for more than 120 years in the Grand Duchy of Luxembourg, Societe Generale Bank & Trust (SGBT) is the oldest foreign bank in the country. From the outset, it supported the development of Luxembourg’s industrial sector and contributed to the emergence of the financial centre. With its wealth of experience, it has developed all the capabilities of a multi-specialist bank, providing services to corporate clients, institutionals and high net worth individuals, and is supported by an active trading room. As a whollyowned subsidiary of the Societe Generale Group, it also benefits from its solidity and its expertise.