‘Inflation Fever’ is finally breaking — but central banks won’t stop raising rates

(Bloomberg) — Global inflation is finally taking off, even if it is set to remain too hot for the world’s central bankers to like.

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As economic growth slows, prices of key raw materials – from oil to copper to wheat – have fallen in recent weeks, easing pressure from the cost of manufactured goods and food. And it’s getting cheaper to move these things as supply chains slowly recover from the pandemic.

After the worst price shock in decades, the speed at which relief arrives will vary, with Europe in particular still struggling. But for the world as a whole, analysts at JPMorgan Chase & Co. they estimate that consumer price inflation will ease to 5.1% in the second half of this year — about half of what it was in the six months to June.

“Inflation fever is breaking,” says Bruce Kasman, the bank’s chief economist.

This does not mean an early return to the subdued inflation much of the world enjoyed before the twin shocks of Covid-19 and the war in Ukraine — or an end to monetary tightening any time soon.

Fed hike still

Rents and labor-intensive services are likely to continue to get more expensive, with labor markets tight and wages on the rise. And there are broader forces at work, from slowing globalization to sluggish labor force growth, that may keep price pressures on bubbles.

The world’s major central banks, which failed to see the pandemic’s price shock coming, are set to continue raising interest rates even as inflation picks up. The Federal Reserve, the European Central Bank and the Bank of England are expected to raise interest rates again in September.

Fed Chairman Jerome Powell left the door open for another jumbo hike of 75 basis points next month, telling fellow central bankers in Jackson Hole on Friday that the recent retreat in US inflation “falls well short” of what they want for policy makers to see. On the day, ECB Executive Committee member Isabel Schnabel said that “central banks must act strongly.”

Some central banks overstepped by the Fed to raise interest rates may take advantage of cooling price pressures to stop tightening moves.

The Czech National Bank this month left policy unchanged, while Brazil’s central bank is expected to do the same in September. And the Reserve Bank of New Zealand may be nearing the end of its aggressive moves, Governor Adrian Orr told Bloomberg Television from Jackson Hole.

The rising cost of living has politicians as well as central bankers feeling the heat – especially in Europe, where gas prices more than seven times higher than a year ago have sparked an energy emergency.

Inflation in the euro zone is forecast to accelerate beyond July’s record 8.9%, and Citigroup Inc. predicts it could top 18% in the UK, partly because the cap on energy bills has just been lifted. All sorts of once unlikely proposals, from nationalization to decentralization, have been floated to deal with the crisis.

The U.S., by contrast, will experience the fastest slide in inflation among advanced economies, thanks in part to the dollar’s strength, JPMorgan economists say.

That won’t stop the Fed from tightening in restrictive territory. Anna Wong, chief US economist at Bloomberg Economics, expects the Fed will eventually need to raise interest rates by as much as 5% to rid the US of its inflation problem.

“Really the issue”

However, the recent decline in several major commodity markets should help lower prices across the global economy:

  • Benchmark crude oil futures have fallen about 20% since early June

  • Prices for metals, lumber and memory chips have retreated from their highs

  • The United Nations food cost index fell nearly 9% in July, the most since 2008

Much of this appears to come from slack demand. That’s partly because consumers are moving away from unusual shopping habits that emerged during the pandemic lockdown, when people spent less on services like hotel rooms or gym memberships and more on goods like exercise bikes and home computers. Goods inflation “will come down a lot,” says Jan Hatzius, chief economist at Goldman Sachs Group Inc.

The rebound in commodity prices also reflects the fact that household budgets are increasingly stretched — and economies are slowing worldwide.

Most of Europe is expected to fall into recession in the coming months as the energy crisis weighs on the winter. China remains hamstrung by its Covid Zero policy and a slump in the property market, with implications for commodity prices. In the US, the Fed’s rate hikes have dampened the once bullish housing market and made high-tech companies wary.

Even with recession risks rising, bond investors don’t see central banks easing in the near future. Investors are currently betting that by next March the Fed will have raised interest rates to around 3.75%, while the ECB’s benchmark will be up to 1.75% and the UK’s at 4%.

“Inflation is really the problem and remains well above central banks’ targets,” said John Flahive, head of fixed income investments at BNY Mellon Wealth Management. “They don’t want to make the mistake of cutting interest rates and watch inflation come back.”

‘I’ve seen the worst’

A sure sign of slowing demand, according to Morgan Stanley economists, is that import growth in major economies – after adjusting for inflation – is now subdued, while exports from Asia, the world’s factory, are starting to weaken .

Easing logistics logjams also contribute to lower prices. The New York Fed’s index of global supply chain pressures has fallen to its lowest level since early 2021. Short-term shipping is falling, ocean transit times are shortening and companies are even beginning to grumble about bloated inventories.

“We were getting about a 65% service level from our strategic suppliers. That’s up to a plus 90 percent now,” Randy Breaux, president of Motion Industries Inc., an Alabama-based supplier of industrial components, said at a conference this month. “We really think we’ve seen the worst of the supply chain issues.”

If that’s the case, the Fed may not need to raise interest rates as much as feared to dampen demand and rein in inflation, according to Apollo Management chief economist Torsten Slok.

However, even if goods prices slow, there is a risk that post-lockdown spending shifts will push up the price of services such as going to the movies or staying in hotels. These can turn out to be stickier.

The cost of renting in the US, in particular, is fueled by a shortage of affordable housing. That could put upward pressure on inflation in 2023 and “maybe beyond,” says Goldman’s Hadjius.

“Not too far”

Rising wages could also keep inflation down for longer.

Labor costs are by far the biggest cost for many businesses, especially in service industries. With labor markets in the US and Europe still tight, companies are being forced to raise wages. To maintain profits, businesses would then have to pass on their higher wages to consumers.

“We are quite concerned about a wage-price spiral,” says Robert Dent, senior US economist at Nomura Securities. “It may already be happening to a degree.”

There is also the argument that inflation will not return to pre-Covid levels because the world was already ready to change. Globalization is unraveling—a process accelerated by the war in Ukraine—and measures to address climate change could add another layer of costs, at least in the short term.

In a report this month, economist Dario Perkins of TS Lombard predicted that such forces will combine to create what he calls a “new macro-hypercycle.”

Central banks “will try to prevent this secular transition, even at the cost of a recession,” but “they cannot stand in the way of structural change,” he wrote. “The persistent era of ‘low inflation’ is over”.

For now, at least, there is a growing consensus that the worst of the current inflationary episode is over for many economies, even if there is some doubt about how fast the decline will be and how far it will go.

“Peak inflation is not far away and should be set soon,” said Priyanka Kishore of Oxford Economics. “Of course there can be extreme values. But this is more due to idiosyncratic country factors than global price pressures.” Read more:

  • Pimco is among bondholders calling for an end to the era of low inflation

  • Powell talks tough, says rates likely to stay high for some time

  • US inflation peaks, but debate rages over what’s next

  • China plans more fiscal stimulus as economic outlook darkens

  • European energy is soaring as pressure mounts on leaders to ease the pain

  • Rising UK energy bills point to higher inflation and rates

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