Repeated banging on the base of the bottle yields little or no sauce, until suddenly one blow allows the condiment to break through. (ddp)

Company storeroom and warehouse inventories will play an important role in the inflation story over the next twelve months. In addition, a dynamic known as the ketchup effect could mean a supply surge at some point, which could exert deflationary pressure.

For seasonal products like clothing, inventory can drive down prices at certain times of the year. Whenever a seasons or fashions change, retailers need to get rid of the old to make way for the new. If a product is seasonal, or subject to the trends of fashion, inventory can drive down prices at certain times of the year.

The pandemic caused many retailers to stop holding inventory. For example, with restrictions still in place retailers did not buy in large amounts of clothing during the first half of 2020. US clothing retail inventory in May 2021 was the lowest value it had been in almost eight years, so there was no need for price discounts to clear inventory as the summer approached.

The lack of unwanted inventory means that inflation was higher than normal in the early summer. However, products like clothing will be a disinflation force in the future. As economies normalize, inventory holdings will normalize. The pattern of discounting prices in seasonal sales will go back to normal, and push inflation lower.

Next year, the year-on year inflation rate will be comparing summer sales in 2022. With the lack of summer sales in 2021, and deflation is the likely outcome in the relevant sectors. The impact of inventories on summer sales should drive inflation lower for selected goods and services.

The ketchup effect

A far bigger potential impact is the tomato ketchup effect. The nature of tomato ketchup is that it does not pour out of a glass bottle very easily, and ketchup can become stuck in the neck of the bottle. Repeated banging on the base of the bottle yields little or no sauce, until suddenly one blow allows the condiment to break through. The result is that the gourmet diner finds their food deluged with far more ketchup than any sensible human being could ever want to consume.

The same effect can take place in global supply chains. If a long and complex supply chain is experiencing a shortage or delivery problem with one component, the end product cannot be completed. There is, in fact, a bottleneck. Once the problem is resolved, and with all the other parts of the product ready and waiting to go, there is a possibility of a sudden supply surge hitting the market and exerting disinflationary pressure.

The tomato ketchup effect only occurs if there are individual components that are in short supply (for whatever reason). If there is a more general supply-demand imbalance, it is unlikely that there will be a future supply surge.

As the global economy recovered from the pandemic, production increased relatively quickly. Global manufacturing production and global trade both exceeded pre-pandemic levels in the first quarter. Consumer spending was still below pre-pandemic levels in all developed economies in the first quarter. This pattern does at least challenge the idea of a general supply-demand imbalance. Combined with the patterns of inventories in producers and retailers, this does suggest the potential for a future ketchup effect.

A supply bottleneck does not have to mean inflation, maybe just a longer wait before a product is delivered. It is noticeable that for all the hue and cry of a microchip shortage, microchip import prices are still in deflation territory in many economies.

Inventories data suggests some disinflation impulse in developed economies over the next few quarters. The ketchup effect could add to disinflation forces—although, ironically, it should be noted that actual condiments prices are already a source of consumer price deflation in the world's developed economies.

Main Contributor: Paul Donovan, Chief Economist, UBS Global Wealth Management.

For more, see the full report Will tomato ketchup kill inflation? 17 August 2021.