‘Inflation Fever’ Finally Breaks – But Central Banks Won’t Stop Rising Rates

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(Bloomberg) — Global inflation is finally coming to a head, even if it will remain far too high for the world’s central bankers.

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With economic growth slowing, prices for key commodities – from oil to copper and wheat – have fallen in recent weeks, putting pressure on the cost of manufactured goods and food. And it’s getting cheaper to move those things, as supply chains are slowly recovering from the pandemic.

After the worst price shock in decades, the speed at which aid arrives will vary, with Europe in particular still struggling. But for the world at large, analysts at JPMorgan Chase & Co. that consumer price inflation will fall 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,” said Bruce Kasman, the bank’s chief economist.

That doesn’t mean an early return to the subdued inflation that much of the world enjoyed before the twin shocks of Covid-19 and the war in Ukraine – or the end of monetary tightening in the near term.

Fed is still walking

Rents and labour-intensive services are likely to become increasingly expensive, with tight labor markets and rising wages. And broader forces are at work, from slowing globalization to subdued labor force growth, that could let price pressures bubble up.

The major global central banks, which did not see the pandemic price shock coming, will continue to hike interest rates even as headline inflation peaks. The Federal Reserve, the European Central Bank and the Bank of England are all expected to raise interest rates again in September.

Fed Chair Jerome Powell left the door open to another jumbo increase of 75 basis points next month, telling fellow central bankers in Jackson Hole on Friday that a recent decline in U.S. inflation is “far behind” of what policymakers want. to see. ECB board member Isabel Schnabel said “central banks must act strongly”.

Some central banks that were quicker than the Fed to hike rates could take advantage of the cooling price pressures to interrupt their tightening moves.

The Czech National Bank left its policy unchanged this month, while the Brazilian 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 actions, Governor Adrian Orr told Bloomberg Television from Jackson Hole.

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With the rising cost of living, politicians and central bankers alike are feeling the heat — especially in Europe, where natural gas prices more than seven times higher than a year ago have sparked an energy emergency.

Euro area inflation is expected to accelerate above July’s record 8.9% and Citigroup Inc. predicts it could exceed 18% in the UK, in part because a cap on energy bills has just been lifted. All sorts of once improbable proposals, from nationalization to rationing power, have been put forward to deal with the crisis.

The US, on the other hand, will experience the fastest rate of inflation in advanced economies, thanks in part to the strength of the dollar, JPMorgan economists say.

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

‘Really the problem’

Still, the recent decline in several key commodity markets should help push prices in the global economy:

  • Crude oil benchmark futures are down about 20% since early June

  • Prices for metals, wood and memory chips have fallen from their highest point

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

Much of this seems to stem from declining demand. That’s partly because consumers are moving away from the unusual shopping habits that emerged during pandemic lockdowns, when people spent less on services like hotel rooms or gym memberships, and more on goods like exercise bikes and home computers. Commodity inflation “will decline significantly,” said Jan Hatzius, chief economist at Goldman Sachs Group Inc.

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

Most of Europe is expected to slide into recession in the coming months as the energy crisis takes its toll over the winter. China continues to be hampered by its Covid Zero policy and a depressed real estate market, with spillovers to commodity prices. In the US, Fed rate hikes have undermined the once buoyant housing market and made high-tech companies cautious.

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Even as recession risks mount, bond investors don’t see central banks in it for the foreseeable future. Investors are currently betting that by March next year 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 to 4%.

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

‘Seen the worst’

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

Reducing logistical problems also contributes to lower prices. The New York Fed’s global supply chain pressure index has fallen to its lowest level since early 2021. Short-term shipping rates are falling, ocean transit times are shortening and companies are even complaining about bloated inventories.

“We received a service level of about 65% from our strategic suppliers. That’s now a 90% plus,” Randy Breaux, the president of Motion Industries Inc., an Alabama-based industrial component supplier, told a conference this month. “We really think we have the worst supply chain problems. seen.”

If so, the Fed may not need to raise as much as feared to reduce demand and curb inflation, according to Apollo Management chief economist Torsten Slok.

But even if the prices of goods fall, there is a risk that the post-lock spending shift will push up the price of services such as going to the movies or staying in hotels. Those may turn out to be stickier.

US rental costs, in particular, are being pushed up by a lack of affordable housing. That could put upward pressure on inflation into 2023 and “maybe even beyond,” Goldman’s Hatzius said.

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‘Not that far’

Rising wages can also prolong inflation.

Labor costs are by far the largest expense for many companies, especially in the service industry. With labor markets in the US and Europe still tight, companies are forced to raise wages. In order to maintain profits, companies would then have to pass on their higher wage costs to consumers.

“We are very concerned about a wage-price spiral,” said Robert Dent, senior US economist at Nomura Securities. “Maybe it’s already happening to some 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 fraying – a process accelerated by the war in Ukraine – and action to tackle climate change could, at least in the short term, add an additional layer of costs.

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

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 shifts,” he wrote. “The ongoing ‘low-flation’ era is over.”

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

“The inflation peak is not far from here and should happen soon,” said Priyanka Kishore of Oxford Economics. “Of course there can be outliers. But this is due more to idiosyncratic country-by-country factors than global price pressures.” Read more:

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

  • Powell talks hard, says rates will likely remain high for some time

  • US inflation peaks in sight, but debate rages on what comes next

  • China plans more fiscal stimulus as economic outlook darkens

  • European energy soars as pressure on leaders to ease pain

  • Rising energy bills in the UK point to higher inflation and tariffs

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