Concerns about inflation have dominated headlines for months: at first it was thought (by central banks at least) to be a one off effect of the post pandemic demand for goods and services; at the end of last year, central banks changed their tune and declared inflation more persistent, with a consequential requirement for consistent interest rate rises. Now there is increasing concern that the global economy is heading into recession, with an anticipated associated fall in demand that should in theory result in a fall off in inflation.
Can we therefore expect inflation to fall quickly back to more ‘normal’ levels (2-3%) if the global economy does slow down markedly in the coming months?
What has caused the current high levels of inflation?
Much of the current bout of inflation has been caused by 4 main factors:
- Stronger than expected post pandemic demand meeting supply chain bottle necks caused by under resourced industries and logistic chains being out of kilter
- Long term under investment in the ‘old’ energy sector
- The Ukraine war forcing a spike in prices of all commodities, including food
This is now impacting wages, with employees expecting increases in line with inflation, especially in those sectors which are significantly under resourced.
There is a concern that unless the labour market weakens, inflation expectations will become ‘baked in’, creating a wage inflation spiral.
What impact can rising interest rates – and any other factors – be expected to have?
The US Federal Reserve (the world’s most important central bank) has led the way in aggressively raising interest rates and has signalled that it will continue doing so until inflation has been brought back down to more acceptable levels.
Rising interest rates have a number of consequences, the two main ones being:
If businesses and consumers do alter their spending /investment plans markedly in anticipation of the impact of higher interest rates, in order to make sure that they don’t leave themselves too exposed financially, there is a chance that this could slow demand for goods and services sufficiently to bring inflation steadily back down. However, there are few commentators willing to bet that inflation will fall back down to the levels seen in the last 10 years.