Is US inflation set to jump?

Federal Reserve chief Janet Yellen has hinted at a rise in interest rates that could see a surge in US inflation.

Markets are now so in thrall to central banks that their every utterance, no matter how banal, vague or contradictory, is splashed across the press. Last week, the spotlight was on US Federal Reserve chair Janet Yellen. She "is not noted for her specificity", as Alastair Winter of Daniel Stewart puts it, but she actually said something quite interesting this time.

She thinks that the weak economic data of recent weeks will prove to be "transitory". Assuming the economy continues to strengthen, interest rates are likely to rise "at some point this year".US rates haven't risen in over a decade.

The reason this raised eyebrows was that the weak data had persuaded some that rate hikes might be delayed until as far out as 2016. Last year, the US bounced back from a first-quarter dip, and it was supposed to be a similar story in 2015.

First-quarter GDP grew by just 0.2% on an annualised basis, according to the first estimate. But a fall in industrial production last month, along with weak retail sales, prompted fears the rebound had run out of steam, while economists at the Fed's Atlanta branch had predicted just 0.7% growth in the second quarter.

But the Fed seems to think there's no reason to worry. Fears of stagnation were overdone, says Paul Ashworth of Capital Economics. There hasn't been much hard data on second-quarter activity yet, and in any case there is no obvious reason why the recovery should have been derailed.

A relatively closed economy such as the US would not be unsettled by a strong currency. The US shrugged off a fiscal tightening worth 7% of GDP between 2010 and 2014. If the recovery survived that, "it can survive almost anything".

Meanwhile, the labour market is getting tighter, with wages and salaries rising at their fastest rate in three years and unemployment at a post-crisis low. Core inflation (stripping out food and energy costs) has risen to an annual rate of 1.8% after a 0.3% rise in April, the biggest monthly jump in three years. "The Fed can't wait forever to raise interest rates," as Ashworth says.

Indeed, even though it at least seems less inclined to postpone rate hikes now, central banks have never been much good at withdrawing liquidity before economies and markets overheat. So an unexpected jump in inflation, and steeper-than-expected rate hikes to contain it, are still the main danger to overheated markets in the months ahead.

Recommended

What the return of the bond vigilantes means for investors
Government bonds

What the return of the bond vigilantes means for investors

The US Federal Reserve is dancing to the tune of the bond vigilantes, says Max King. Here’s what that means for stockmarket investors, the economy, an…
6 Sep 2022
US inflation may have peaked, but it remains a threat
US Economy

US inflation may have peaked, but it remains a threat

US inflation fell to 8.5% in July, down from 9.1% the previous month. But structural, not transitory, forces are pushing inflation higher. It could be…
17 Aug 2022
Is the US in recession and does it matter?
US Economy

Is the US in recession and does it matter?

There's a heated debate over whether the US is in recession or not. But why does it matter? John Stepek explains
29 Jul 2022
What the death of the “Greenspan put” means for investors
US Economy

What the death of the “Greenspan put” means for investors

The Fed’s latest interest-rate rise shows that the “Greenspan put” – the idea that central banks will intervene if markets look like crashing – is dea…
28 Jul 2022

Most Popular

Why everyone is over-reacting to the mini-Budget
Budget

Why everyone is over-reacting to the mini-Budget

Most analyses of the chancellor’s mini-Budget speech have failed to grasp its purpose and significance, says Max King
29 Sep 2022
How the end of cheap money could spark a house price crash
House prices

How the end of cheap money could spark a house price crash

Rock bottom interest rates drove property prices to unaffordable levels. But with rates set to climb and cheap money off the table, we could see house…
28 Sep 2022
Why UK firms should start buying French companies
UK stockmarkets

Why UK firms should start buying French companies

The French are on a buying spree, snapping up British companies. We should turn the tables, says Matthew Lynn, and start buying French companies. Here…
28 Sep 2022