Two years after inflation began its rapid rise, investors, economists and policymakers remain divided over the way forward.
Yes, headline inflation in major developed economies has retreated from multi-decade highs, COVID-19 inflationary impulses, such as soaring used car and semiconductor prices, are fading, and Europe’s gas crisis has subsided.
But labor markets are tight and price pressures, excluding volatile energy and food pressures, remain elevated.
The stakes are high for money makers and traders, who have been wrong time and again about inflation.
Here are arguments for and against inflation falling rapidly towards the 2% target of most central banks.
ARGUMENTS FOR RAPID RETREAT
1- ENERGY PRICES
The fall in energy prices is holding back headline inflation. With natural gas prices in Europe at their 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, since the peak of 9.1% reached last June.
China’s reopening has boosted China’s prices. petroleum. But at $83 a barrel, the Brent crude it is still 40% below the $139 reached just after the invasion of Ukraine. It should reach an average of $89.23 this year, according to a Reuters poll.
2- SUPPLY CHAINS TAKE HOLD
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 are “back to normal,” as pressures are the lowest since before the pandemic, with China’s reopening of strict COVID-19 restrictions the latest source of improvement.
3- WHAT SPIRAL OF PRICES AND WAGES?
Yes, labor markets are tense. But the labor cost index monitored by the Fed is slowing and posted its smallest rise in a year in the fourth quarter.
“If you’re dealing with a fast-growing economy, where demand for workers far outstrips supply, wages and labor costs are expected to rise,” says James Knightley, chief international economist at ING (AS:INGA).
Even central bank “hawks” like Germany’s Joachim Nagel accept that a price and wage spiral is not developing. By contrast, corporate profits have accounted for most of the domestic pressures on euro zone prices since 2021, ECB data show.
A recent IMF study dating back to the 1960s concluded that only in a small minority of cases where wages and inflation rose simultaneously for several quarters did sustained inflation occur.
ARGUMENTS FOR STICKY INFLATION
1- HISTORY LESSON
Since 1970, when prices rose an average of 8% in 14 developed markets, it took at least six years for inflation to return to 3%, according to an analysis by Research Affiliates.
Data from the London Business School shows that inflation in 21 countries since 1900 skyrocketed during wars and energy crises, and was then followed by a series of smaller peaks rather than a clear downward trajectory.
According to a Reuters poll, headline inflation in the United States would stand at 2.7% by the end of 2023, with estimates of up to 4.6%. Eurozone inflation is expected to be between 2% and 5.2% by the end of the year.
2- PAYMENT DAY
The rigidity of the US labour market suggests that inflation will remain stable. Recall that the creation of 500,000 new jobs in January led to a further increase in bets on interest rate hikes. Wage increases may not be boosting inflation now, but the risk is that they will. Euro zone consumer wage growth expectations continue to rise, according to ECB data.
ECB officials have stated that if high inflation persists, inflation-commensurate wages are more likely to be demanded. In February, Federal Reserve officials considered that wage growth kept service prices 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 commodity buyer.
Idanna Appio, portfolio manager at First Eagle Investments, says the impact on energy prices has yet to be fully felt, and will increase as Chinese travel returns. Analysts polled by Reuters expect China to import a record amount of crude in 2023. Chinese factories continue to move forward. February’s manufacturing activity rose at the fastest pace in more than a decade.