How inflation has come back from the dead

Inflation has made a sudden comeback. America’s core consumer price index (CPI) – which strips out volatile food and energy costs – jumped 0.6% in July compared to June, the biggest monthly rise since 1991. In annual terms, core US CPI advanced by 1.6% last month. In Britain inflation is more subdued, with prices rising by 1% year-on-year in July, but that figure still surprised on the upside. UK core inflation rose by 1.8% year-on-year last month.

Jonathan Allum notes in The Blah! newsletter that even in Japan, “where inflation went to die”, producer prices rose by 0.6% in July on the previous month, although they remain down on the year. In China inflation rose to 2.7% last month. Widespread flooding in the country’s south has caused a spike in food prices.

The jury is still out

The “shocking” US inflation point is certainly a challenge to those like me who think we are heading for a deflationary meltdown, says Albert Edwards of Société Générale. Nevertheless, there is not enough data to draw firm conclusions yet. Falling rents have yet to feed through to the inflation figures, for example.

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It is too early to talk of a new inflationary trend, agrees James Knightley in ING Think. Rising inflation may have been caused by an “unwinding of the strains” caused by Covid-19 shutdowns. But with 30 million unemployed in America, wages – the crucial input into prices – are going nowhere fast.

Deflation remains the greater immediate threat, says the Financial Times. The economy is just too weak to drive a classic “wage-price spiral”. That said, central bankers are coming under greater pressure than ever before to bow to the will of politicians, who prefer easy money. If the bankers don’t have the guts to raise interest rates “when the time comes” then we might eventually find ourselves back in the 1970s.

The pandemic has drawn the curtain on the era of low inflation, says Philip Aldrick in The Times. Since the fall of the Berlin Wall globalisation has kept labour prices low – think of all those cheap Chinese imports. Yet now trade decoupling is undoing some of those gains (see page 4) and the baby boomers are retiring to be replaced by a smaller pool of workers who will consequently have more bargaining power to demand wage hikes. “It’s hard to argue against demography”.

MoneyWeek’s view is that the economy is heading for an inflationary denouement. The Bank of England has unleashed £300bn in quantitative easing in a matter of months, equivalent to about 35% of all government spending in the last financial year. Unlike in 2008, this new money is not being used to repair holes in bank balance sheets but is likely ultimately to find its way into the real economy, causing rising prices.