By Mike Dolan
LONDON (Reuters) – What if the “last mile” is a breeze?
Despite what seems like euphoria about disinflation and interest rate easing, it’s also fashionable to speak of the hard yards of that final sticky trudge of inflation back to 2% goals. – even if the finishing line is already in sight.
Tuesday’s news of a surprising, if modest, tick up in the monthly U.S. consumer price inflation reading last month – even as annual rates fell back to June levels and six-month annualised core rates dropped below 3% for the first time in two years – once again gave vent to some of that commentary.
What’s more, the Federal Reserve – and most likely the European Central Bank and Bank of England – will likely this week harp on about the difficult final furlong too. Keeping the rhetorical pressure of caution is part of their strategy of containing expectations, so no one wants to sound all clear.
But there’s an argument that this may be misplaced and central banks will soon find themselves grappling with an inflation undershoot – perhaps explaining some of the high octane interest rate pricing now in financial markets.
The main reason cited for thinking of a muddy slog through the final percentage point or so of disinflation is that historically there have been aftershocks in inflation spikes due to a variety of catch-up waves in wage claims, rent and corporate pricing.
And yet this inflation spike was unique in origin – seeded by supply chain and energy disruptions as the world rebooted following unprecedented pandemic lockdowns in 2020 and 2021 and then spurred by oil and gas price surges after the Ukraine invasion in 2022. In some respects, we’ve had the aftershock.
The speed of the disinflation, for many economists, is staggering and sides with the dogged insistence the problem was mostly related to supply distortions and not excess demand – with central banks’ credit tightening merely a credibility-enhancing shot across bows to keep expectations in check.
Euro zone inflation, having spiked over a percentage point more than the U.S. equivalent to a peak of 10.6% a little over a year ago, has collapsed since to within half a point of the ECB’s target – in just 13 months.
Currency hedge fund manager Stephen Jen at Eurizon SLJ – who’s been warning of the risk of a rapid disinflation and a potential undershoot all year – puzzles over why people think the decline will magically stop at 2% thresholds, especially as demand wanes next year just as supply pressures dissipate.
“There was so much opportunistic price gouging in the past two years that a small change in the pattern of demand could lead to sharp price corrections,” Jen wrote, pointing to deep discounting around Thanksgiving sales as an early example.
But eye-balling the collapse of euro zone inflation – and the equally rapid shift in ECB tone it inspired – Jen’s key point is that the bulk of the inflation scare was caused by global supply crunches for all major economies, whose untangling will be as disinflationary for all major economies as it was inflationary to begin with.
“If inflation in the US and Europe has indeed been dominated by ‘global’ or ‘common’ factors, then why should inflation in these two economies not trend downward together in the coming months?” he asked, pressing readers to squint at a chart of both and point out how much ‘local factors’ mattered between the two.
LOOSENING CHAINS
His conclusion is that most U.S. disinflation to date has been due to these global factors and not Fed tightening per se. And so if the full force of Fed hikes has yet to hit hard through next year, the central bank should be extremely worried it has not ‘overtightened’ just to cut across a temporary global supply quirk.
For all the reasonable worries about the sticky “last mile”, the case is pretty compelling.
Where the Fed has been successful in its brutal, if late, hiking cycle has been is containing inflation expectations. In the U.S. alone over the past week, surveys showed households inflation outlook has fallen back to some of its lowest levels in more than two years. Many market-based inflation expectations UJSBEI10YT=RR> are already back close to target.
And that’s despite a sub-4% U.S. jobless rate.
What’s more, there’s ample evidence of post-lockdown bottlenecks having been unjammed.
The so-called ‘big quit’ distorting the U.S. labor market seems to have vanished – with labor force participation rates at post-pandemic highs and just half a point off pre-COVID levels.
A global supply chain pressure gauge compiled by the New York Fed has firmed up this year but it’s basically back to pre-pandemic levels near zero – having collapsed from record highs of late 2021 over the 18 months through the Spring of this year.
And one feature of those pressures, soaring used-car prices due to new auto assembly problems and ship shortages, is rapidly unwinding too. The Mannheim used-vehicle index is down about 25% from its peaks and is still falling at a year-on-year rate close to 6% last month.
Annual oil prices too are also still running in negative territory, with spot prices at almost 6-month lows near 30% below this year’s peaks and half post-Ukraine highs. Global food prices are also running at deflation rates of over 10%.
And wherever a global demand pulse may come from next year, fears all year that it would emanate from a recovering China proved far wide of the mark.
Suffering domestic demand problems and a mega property bust, China outright consumer price deflation is deepening if anything and may be a warning to West and its central bankers about the danger of pushing ahead with a battle that’s over.
In the end, so many of economic mega trends evident before the pandemic – not least ageing demographics, productivity issues and safe-asset demand – may not have changed that much.
In an updated paper presented to different economic forums this year, former International Monetary Fund chief economist Maurice Obstfeld suspected recent seismic changes in interest rates and inflation might not be durable and the opposite problem may yet return.
“Low equilibrium interest rates may well continue periodically to bedevil monetary policy and financial stability.”
The opinions expressed here are those of the author, a columnist for Reuters
(Editing by Marguerita Choy)
