Inflationary pressures appear to be falling, but the outlook is still finely balanced.
- US CPI has dipped to 3%, while UK inflation has dropped to 7.9%
- Energy prices have been important, but core inflation has dropped as well
- However, inflation has a nasty habit of hanging around
It has been an important week for inflation statistics with the US CPI dipping to 3%. Even in the UK, inflation looks like it might be heading lower, with the headline rate dropping to 7.9%, from 8.7% last month. Is it too soon to say that central banks have succeeded in taming rising prices?
In both cases, core inflation – which strips out volatile food and energy prices - has also come down, from 5.3% to 4.8% in the US, and from 7.1% to 6.9% in the UK. As such, while a significant part of the dip in headline inflation can be attributed to a fall in energy prices, it is not the whole picture. Economists were particularly encouraged by the fall in ‘shelter’ (housing) costs in the US, taking this as a sign that the Federal Reserve’s medicine was finally working.
In the UK, there is less room for optimism, and there is no doubt that the Bank of England has a tough decision on its hands. That said, markets responded by pricing in a less severe rate hike in August – from 0.5% to 0.25% - and a lower peak for interest rates, at 5.75%, rather than 6%. This will be welcome for terrified mortgage holders, contemplating a three-fold increase in their monthly repayments.
However, if the experience of the 1970s is anything to go by, inflation has a nasty habit of hanging around. Some economists believe that the genie is out of the bottle on inflation: central banks were too slow to raise rates and rein in quantitative easing after a decade of loose policy and the hangover will be nasty. They point to the tightness of key commodities markets, the breaking down of supply chains, and the transition to renewable energy, as key factors driving inflation from here. There is also no deflationary tailwind from the import of cheap goods from China.
It is plausible that technology makes a difference, such as the growth of AI. Equally, it is possible that the lagged effect of interest rates leads to a slow collapse of the economy. There has even been talk of China moving into a deflationary era.
The inflationary picture is still finely balanced and it is too soon to say whether it is tamed. There are competing forces on either side and the outlook is difficult to predict. Central banks have some tough decision-making ahead.
