Is the fear of inflation over? For and against rigid inflation

Two years after inflation began its rapid rise, investors, economists and policymakers remain divided on the path forward.

Yes, headline inflation in major developed economies has receded from multi-decade highs, the inflationary impulses of COVID-19, such as the skyrocketing prices of used cars and semiconductors, are fading, and the gas crisis in Europe has subsided.

But labor markets are tight and price pressures, excluding energy and food volatiles, remain elevated.

The stakes are high for policymakers and traders, who have been wrong time and time again about inflation.

Here are arguments for and against inflation falling rapidly towards the 2% level, the objective of most central banks.

ARGUMENTS IN FAVOR OF A RAPID BACKWARD

1- ENERGY PRICES

Falling energy prices curb headline inflation. With natural gas prices in Europe At its lowest level since August 2021, 85% below last year’s peak, eurozone inflation is no longer in double digits.

US inflation marked 6.4% in January, the smallest advance since October 2021, from the maximum of 9.1% reached last June.

The reopening of China has boosted oil prices. But at $83 a barrel, Brent crude is still 40% below the $139 reached just after the invasion of Ukraine. It should average $89.23 this year, according to a Reuters poll.

2- SUPPLY CHAINS TAKE PLACE

Supply chain disruptions caused by COVID-19 and the war in Ukraine, key drivers of rising inflation, have subsided sharply.

An index from the New York Federal Reserve suggests that global supply chains have “back to normal” as pressures are at their lowest since before the pandemic, with China’s reopening from strict COVID-19 restrictions the latest source of improvement.

3- WHAT SPIRAL OF PRICES AND WAGES?

Yes, labor markets are tight. But the Fed-tracked labor cost index is slowing, posting its smallest rise in a year in the fourth quarter.

“If you are dealing with a rapidly growing economy, where the demand for workers far exceeds the supply, you would expect wages and labor costs to rise.”says James Knightley, ING’s chief international economist.

Even the “hawks” of central banks, such as Germany’s Joachim Nagel, accept that a price-wage spiral is not unfolding. By contrast, corporate profits have accounted for most of the domestic pressure on euro zone prices since 2021, ECB data show.

A recent IMF study dating back to the 1960s found that only in a small minority of cases where wages and inflation rose together for several quarters did sustained inflation occur.

ARGUMENTS IN FAVOR OF STICKY INFLATION

1- HISTORY LESSON

Since 1970, when prices rose an average of 8% in 14 developed markets, it has taken at least six years for inflation to return to 3%, according to a Research Affiliates analysis.

Data from the London Business School shows that inflation in 21 countries since 1900 spiked during wars and energy crises, and was then followed by a series of smaller spikes rather than a clear downward trajectory.

According to a Reuters survey, headline inflation in the United States would stand at 2.7% by the end of 2023, with estimates as high as 4.6%. Inflation in the euro zone would be between 2% and 5.2% at the end of the year.

2- PAYMENT DAY

The rigidity of the US labor market suggests that inflation will remain stable. Let’s remember that the creation of 500,000 new jobs in January caused a new increase in bets on interest rate hikes. Wage increases may not be driving inflation right now, but the risk is that they will. Eurozone consumer wage growth expectations continue to rise, according to ECB data.

ECB officials have stated that if high inflation persists, wages in line with inflation are more likely to be demanded. In February, Federal Reserve officials considered that wage growth was keeping the prices of services high.

3- CHINESE FACTOR

China’s economic reopening will add to global price pressures as trade and travel boost demand from the world’s biggest buyer of commodities.

Idanna Appio, a portfolio manager at First Eagle Investments, says the impact on energy prices has not yet fully kicked in, and will increase as Chinese travel returns. Analysts polled by Reuters expect China to import a record amount of crude in 2023. Chinese factories keep advancing. Manufacturing activity in February increased at the fastest pace in more than a decade.

Source: Reuters