Climate change: decarbonisation to stoke inflation, but delaying efforts could hit economic growth, returns
Government policies to mitigate the impact of climate change will stoke inflation, but delaying them could depress economic growth and investment returns, according to investment strategists.
Policymakers face a trade-off between the high upfront cost of moving quickly towards net zero carbon targets, and the long-term damage to economic growth caused by rising temperatures if they delay action, they said.
“As global policy kicks into gear and brings the transition risks associated with reducing emissions to life, the accompanying rise in carbon prices from a very low base poses meaningful upside risk to inflation over the next few years,” said Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International in a report on August 16.
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The inflationary impact on China could rise from one percentage point this year to 4 percentage points in 2026, before easing to almost zero in 2031 and turning negative after 2043, he projected. While the impact on the US and Europe ” whose combined emissions are less than China’s ” would be around half or less than in China.
Such potential inflation from the extra costs of doing business because of efforts to decarbonise are underestimated and not yet accounted for by the investment markets, Ahmed reckoned.
Carbon prices refer to the cost of buying emission quotas or taxes on emissions generated while doing business. Investments on infrastructure and industrial processes to abate emissions and improve energy efficiency also add to costs.
Christophe Donay, Switzerland-based Pictet Group’s head of asset allocation and macro research, expects less dramatic inflationary pressure.
With climate mitigation measures, inflation could average 3.1 per cent in China and 2.1 per cent in the US between 2025 and 2030, both barely 0.1 per cent higher than without mitigation, Donay forecast in a report last month.
The average inflation rate for the decade to 2020 was 2.52 per cent in China and 1.73 per cent in the US.
Still, given rising inflationary pressure, adopting an investment strategy that involves a range of real assets like properties, commodities and gold may protect against inflation, he said.
Thanks to large investments in green technologies, global warming mitigation measures could see annual economic growth in China average 4.8 per cent between 2025 and 2030, above 4.7 per cent if no action is taken, Donay said.
Growth in the US, a smaller maker of renewable energy equipment than China, however, may slide to 1.9 per cent with such measures, lower than 2.1 per cent without them.
Incorporating climate considerations may also lower global share markets’ annual returns by 0.3 percentage point to 5.9 per cent in the next decade, Donay said, with emerging markets likely to lose more than developed ones.
However, if the world lets emissions grow at their current pace, China’s economic growth could fall to just 1.4 per cent in the decade to 2040, compared with 3 per cent if climate change impact is excluded, Fidelity’s Ahmed projected.
The respective decline forecast for the US is from 1.9 per cent to 1.2 per cent, while that of emerging markets will crash from 3.6 per cent to 0.2 per cent.
However, not all analysts are convinced about the impact of climate change mitigation on inflation.
The transition to a decarbonised world will be disorderly and the outcome uncertain, mainly because of poor coordination among governments on policy response, said Andrew Zurawski, an associate director focusing on Asia investments at Willis Towers Watson.
“We have no view on whether inflation will be higher or lower, but we believe it will be more volatile,” he said.
Ulrik Fugmann, co-head of environmental strategies group at BNP Paribas Asset Management, has a contrarian view.
Inflationary pressure from climate change will be short term, while decarbonisation technology and sustainable living will drive costs lower in the long term, he argued.
“The biggest deflationary pressure is energy transition, since renewable energy has no fuel cost,” he said. “I see more deflationary than inflationary pressure.”
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