Wells Fargo Expects Inflation to Cool in 2022 but Warns of Risk of ‘Self-Sustaining’ Rent and Wage Increases

By Tom Ozimek
Tom Ozimek
Tom Ozimek
Reporter
Tom Ozimek has a broad background in journalism, deposit insurance, marketing and communications, and adult education. The best writing advice he's ever heard is from Roy Peter Clark: 'Hit your target' and 'leave the best for last.'
December 9, 2021 Updated: December 9, 2021

Wells Fargo said in newly released economic forecast for 2022 that it expects inflation to cool somewhat next year, while warning there’s a risk that COVID-19 interruptions and supply-chain disruptions could trigger “self-sustaining” wage and rent gains and lead to persistent inflation.

Consumer spending is expected to be the main driver of U.S. economic strength next year, with continued reopening likely to provide a boost to frontline service industries that were hit hardest by the pandemic, the Wells Fargo team said in the report, released Dec. 8.

The analysts predict U.S. economic growth will slow to 4.5 percent by the end of 2022 as manufacturing pivots away from the current surge in “catch-up” and “inventory restocking” spending at around the midpoint of the year.

“During this transition, we expect the U.S. economy to navigate through obstacles in the operating environment, including fuel costs and general price inflation, (modestly) higher interest rates, and reduced monetary and fiscal policy support,” the team wrote, predicting that the United States will be the main engine of global growth next year.

Inflation, which in the 12 months through October hit a 31-year high of 6.2 percent, should ease to 4 percent for all of 2022 but remain well above the Federal Reserve target of 2 percent, Wells Fargo predicts.

“A shortage economy will likely keep inflation elevated before supply-chain pressures ease and allow inflation to subside during the year’s second half,” the analysts wrote.

A key risk to the outlook are new COVID-19 variants and outbreaks, with the potential to trigger new restrictions that slow the economy and renewed concerns among workers potentially making the labor crunch more acute.

“Fear of the virus could keep workers at home for longer and delay the recovery in spending on services,” the analysts wrote.

Another key risk is inflation staying higher and for longer.

“The longer that the COVID-19 interruptions and supply-chain disruptions continue, wage and rent gains would have a higher probability of becoming self-perpetuating and generating persistent inflation, especially in services industries,” according to the report.

Higher inflation that outpaces wage gains could also dampen consumer spending, which is a key driver of the U.S. economy, accounting for around two-thirds of GDP. If demand wanes, this could crimp companies’ ability to pass on higher input costs to consumers, potentially impacting businesses’ bottom lines, Wells Fargo said.

Inflation has emerged as a key theme of the pandemic-era economic rebound, rising faster than wages and eroding the purchasing power of Americans. While average hourly earnings rose 5.1 percent over the year in October, a higher 6.2 percent pace of inflation has more than erased those gains, however, with real earnings down 1.1 percent over the year.

Some economists have warned that if inflation stays too high for too long, it could spark the kind of wage-price spiral that bedeviled the U.S. economy in the 1970s.

Still, the overall outlook remains bullish for risk assets like stocks, Wells Fargo analysts said.

“With the economy at a crossroads between strong recovery, on the one hand, and disruptions and inflation, on the other, we believe that investors should still follow the road to continued growth. The economy should stay on track,” said Paul Christopher, head of global market strategy, Wells Fargo Investment Institute, in a video presentation of the report.

Wells Fargo believes equities will outperform fixed income and that U.S. stocks will deliver higher returns than international markets.

Tom Ozimek
Reporter
Tom Ozimek has a broad background in journalism, deposit insurance, marketing and communications, and adult education. The best writing advice he's ever heard is from Roy Peter Clark: 'Hit your target' and 'leave the best for last.'