Why the last mile of the inflation race may be hardest
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Inflation has plunged from its peak levels of a year ago. But some influential economists have a warning: The hardest part of reining in prices still lies ahead.
Why it matters: Even as price increases have slowed, underlying inflation has proven stubborn in the United States and Europe, creating the risks that central banks have to keep rates higher for longer than markets have been pricing in — with all the collateral damage that can cause.
Driving the news: In its annual report, the Bank for International Settlements — the Basel, Switzerland-based central bank for global central banks — writes that the "last mile to price stability may be the most challenging."
- That was echoed by another top official in Sintra, Portugal, where global policymakers are gathering for a conference hosted by the European Central Bank.
What they're saying: Gita Gopinath, second-in-command at the International Monetary Fund, compared the world's inflation battle to "Waiting for Godot."
- "We are still waiting for low inflation to reappear," Gopinath said during a Sintra dinner speech. "We hope, of course, that real life will have a different ending than the play. But as of now, the audience is still waiting."
State of play: The disinflation of the last year has resulted from global supply chains righting themselves after pandemic-caused disruptions and energy prices retreating after the distortions caused by Russia's invasion of Ukraine.
- The argument, in effect, is that inflation is less the result of external shocks like those, and more caused by internal dynamics in major economies — i.e. labor markets, consumer demand, business pricing power and overall inflationary sentiment.
- "This persistence is caused by the fact that inflation is working its way through the economy in phases, as different economic agents try to pass the costs on to each other," ECB president Christine Lagarde said in a speech in Sintra on Tuesday.
Where it stands: Interest rate hikes have been forceful, but the labor market has been resilient — an extraordinary phenomenon that continues to play out on both sides of the Atlantic.
- Pay gains have lagged inflation, and "it would be unreasonable to expect that wage earners would not try to catch up," BIS researchers write — a demand employers may have to bend to if labor markets stay tight.
- "If wages do catch up, the key question will be whether firms absorb the higher costs or pass them on. With firms having rediscovered pricing power, this second possibility should not be underestimated," the report says.
Between the lines: That could make inflation more persistent, a scenario that has particularly concerned central bankers across continental Europe.
- Central banks may "need to react more aggressively in a strong economy in which producers can pass on cost hikes more easily and workers are less willing to accept real wage declines," Gopinath said.
The big picture: Another factor complicating the inflation fight is financial system turmoil that may appear as a result of it.
- BIS warns credit losses that the global economy has so far been spared from may yet put more pressure on the banking system.
- This is more likely during bouts of high inflation, elevated real estate valuations and initial debt levels that are already high. "The current episode ticks all the boxes," the report says.
- "[I]f the stress is acute enough, addressing it without compromising the fight against inflation will require the active support of other policies," including those from governments.
