Global central banks are at odds over how long the surge in inflation will persist. On Thursday, the UK became the first G7 economy to raise interest rates since the start of the pandemic. The US Federal Reserve has said that it will accelerate the reduction of its monthly bond purchases and signalled plans to raise rates more aggressively in 2022. Meanwhile, the European Central Bank is only slightly reining in stimulus.
At issue is the need to balance rising consumer price pressure against the potential hit to economic growth from the Omicron coronavirus variant. One camp claims increases are driven by supply-chain disruptions and will prove transitory. The other expects prices to continue to rise for some time.
In the US, where consumer price increases are at a near 40-year high, gains have been concentrated in goods most affected by a combination of supply constraints and rising demand. Shortages of things such as semiconductors will ease once supply-chain disruptions caused by Covid-19 become less severe.
But dismissing inflation as “pandemic-related” and therefore bound to pass risks underestimating the pandemic’s duration. More variants are expected to be generated. The Fed has acknowledged that this means there is a good chance inflation will remain high.
There is also the psychological component to inflation. If consumers expect prices to keep going up, they will try to purchase more now. This in turn will push prices even higher. That could eventually spill over into wages, creating a wage-price spiral. Inflation becomes self-perpetuating.
For now, both the stock and bond markets seem to take the view that inflation will moderate. The yield on benchmark 10-year Treasuries, at 1.42 per cent, remains less than half the level it was in 2018. But that view underestimates the extent of structural changes in the global economy that have been accelerated by the pandemic. The days of low inflation and strong growth are out of reach.
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