Courtesy / NBT Bank
Kenneth J. Entenmann is chief investment officer and chief economist at NBT Wealth Management.
Updated: March 25, 2022
How inflation will affect businesses in the foreseeable future
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Businesses can expect inflation to be an issue into 2023, but supply chain issues and labor shortages should improve in coming months.
By Kenneth J. Entenmann, NBT Wealth Management
Hopefully you don’t have whiplash from the dramatic change in inflation projections over the last year. Just recently, inflation was considered “transitory,” the result of COVID-created supply chain disruptions and demand shifts to goods from services.
Once the pandemic subsided, it was expected that inflation would return to its pre-COVID trend of 2% or less. Unfortunately, inflation is now much more pervasive and persistent than economists predicted. It is unlikely inflation will retreat without consequences for households and businesses.
There are three primary drivers of inflation: supply chain disruptions, labor shortages and energy prices. The most likely place for improvement is the supply chain. The pandemic drove a dramatic shift toward goods (appliances, electronics, furniture, home improvement, etc.) and away from services (hotels, restaurants, travel). This shift shocked the economy and our “just in time” approach to inventory couldn’t meet the COVID-induced demand shift.
The good news is there is evidence that demand is returning to “normal,” as anyone who has traveled recently can attest. While certain areas, such as semiconductors and energy, will remain supply constrained, supply chain issues should continue to diminish over time.
The labor market continues to be very tight. Job openings remain at record highs yet the rebound in the labor participation rate remains sluggish. There are signs that individuals are grudgingly returning to the workforce, and that will help. However, the labor shortages will persist in the short-term and businesses will be required to assess their wage levels to retain and attract talent.
There is no quick fix to energy inflation. Demand for fossil fuels is projected to grow for the next 10 years while the supply remains well below pre-COVID production. This is a result of a dramatic drop in capital expenditures by the energy industry, reduced financing of the energy industry by Wall Street, heightened government and climate regulatory burdens and, of course, the Russia-Ukraine crisis. Unfortunately, the country cannot “flip the switch” and immediately increase energy supply. This is especially true for the New England region. It will take time.
What's ahead
Inflation will remain an issue for business throughout 2022 and into 2023. Of course, every business will be affected differently. However, businesses are well positioned to manage through this inflation spike for several reasons:
- The supply chain disruptions have already begun to improve and will likely get better as demand returns to “normal” and production ramps up to meet that demand.
- The labor markets will begin to improve as more individuals reenter the labor force.
- Business’ balance sheets have never been stronger. A combination of intense expense control, government support (PPP loans, industry supports, etc.) and remarkable adjustment of business models in a COVID world have left corporate balance sheets in strong condition with large stockpiles of cash.
- While energy consumption is different for every company, business is far more energy efficient than ever before. Energy as a percentage of overall costs has been declining since the 1970s — the last time we had an energy shock. Efforts to reduce costs and improve efficiency during the pandemic have only improved the ability of businesses to manage the energy price increases.
- Corporate earnings have been incredibly resilient during the pandemic. Businesses have been able to pass increased costs through to the consumer, at least so far. Whether that remains the case will be critical to business success in 2022.
- The Federal Reserve Bank is on the case. The Fed has a dual mandate — employment and inflation. With unemployment below 4%, the Fed now can focus on inflation. It raised interest rates for the first time on March 16 and has forecast additional rate hikes for the rest of 2022. Hopefully, this action will slow the pace of inflation.
Inflation is likely to persist in 2022 and it will take some time to control it. Business has demonstrated a remarkable ability to manage through the pandemic and the ongoing bout of inflation. Businesses will have to remain vigilant and continue to adjust to inflation but are in a solid financial position to do just that.
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