President Biden and Federal Reserve chair Jerome Powell are committed to fighting inflation. But the two may face an uphill battle bringing consumer prices down due to a factor that many experts may not be pricing into the economic picture: the rise of ESG investing.
Investors have increasingly been looking to back companies that support sustainable environmental, social and governance practices. But some may be ignoring the impact the so-called “greenification” of the global economy is having on inflation, according to a recent report by Seema Shah, chief global strategist at Principal Global Investors, an asset management firm. She called the phenomenon “en-flation.”
Shah said that the increased focus by big businesses and governments on cleaner environmental policies could be inflationary in the short-term.
“I can’t see a reason why the Fed will not acknowledge the ‘E’ in its inflation outlook for much longer,” Shah said in an interview with CNN Business. “We will see more central banks consider climate change, and I suspect the Fed will do so, too. The green movement is not going away.”
So what is it about “going green” that could be a problem on the inflation front?
For one, Shah noted that higher costs for carbon credits, or permits that companies can buy to offset emissions, could potentially get passed on to consumers.
She also pointed out that more businesses will potentially need to pay penalties if they don’t meet UN climate targets, something that also could lead companies to raise prices in order to preserve profit margins.
Businesses may also face higher costs for labor, capital spending and other expenses associated with the transition to a more eco-friendly business model, Shah said.
Green monetary policy could mean more red for the market in the short-term
Of course, this is a necessary price that businesses — and consumers — will have to pay now for the good of the planet long-term.
But it could come at the expense of earnings and shareholder returns in the short-term if companies have to eat some of those increased costs that they aren’t able to pass on to customers.
“Someone is going to have to eat these costs,” Shah said. “It’s either consumers or businesses.”
It’s also a sign that inflation won’t be “transitory” as Powell, until recently, has repeatedly claimed.
“The outlook for inflation is one that should stay elevated for the next 10 years due to ESG cost integration and a tight oil and natural gas supply,” Sebastien Galy, senior macro strategist with Nordea Asset Management, said in a recent report.
The ESG revolution is just one more reason why the Fed will continue to have difficulty tamping down price pressures anytime soon — unless it begins to tighten monetary policy by raising interest rates, said Phil Orlando, chief equity market strategist with Federated Hermes.
“The Fed tightening is the right thing to do in light of how ugly inflation is,” Orlando said. “It is not temporary or transitory. This is sustainable.”
Orlando is predicting that the Fed will need to hike rates twice next year and four more times in 2023 in order to bring inflation under control. And as long as businesses continue to spend more to be good environmental stewards, that could push inflation pressures up even further.