A transitory respite from inflation

UK consumer prices rose by 2% year-on-year in July – less than expected. And in the US, month-on-month inflation fell to 0.5%, down from 0.9% in June. But this respite could be short-lived.

When does “transitory” inflation “become persistent?” asks The Wall Street Journal. The US Federal Reserve has spent the year insisting that soaring prices are a “transitory” effect caused by reopening. Yet US consumer prices rose by 5.4% in July compared with a year earlier for the second month running. Energy prices are rising. Ordinary workers are being hurt. “Real (after inflation) average hourly earnings have declined for seven consecutive months.” This week we learnt that UK consumer prices rose by 2% year-on-year in July

Price pressures pause 

Some of the data supports the transitory case, says The Economist. Month-on-month US inflation fell to 0.5%, down from 0.9% in June. The inflationary spike has arguably been concentrated in areas stressed by the reopening, such as used cars and airline tickets, which have seen massive demand as people start travelling again. As the economy normalises, the reopening effects should ease. “Airline fares fell slightly, as did the cost of furniture.” Falling bond yields suggest bond markets agree with the Fed. 

This respite is itself “transitory”, says Lisa Beilfuss in Barron’s. US politicians are working on spending bills worth a total of $4.5trn. Not all of that will become law, but a great deal probably will. As Barry Knapp of Ironsides Macroeconomics notes, “you have to go back to the 1960s to see such massive fiscal spending during an economic boom”. Loose fiscal and monetary policy during that decade ultimately laid the groundwork for “the Great Inflation of the 1970s”. “Ongoing supply-chain strains and labour market shortages” will also keep prices buoyant, say Augusta Victoria Saraiva and Kyungjin Yoo on Bloomberg. A Bloomberg survey finds that economic “forecasters now expect the consumer price index to remain above 5% on a year-over-year basis at the end of the third quarter” and to stay well above target into next year.  

An end to QE? 

The Fed has “little room for error”, says Vivien Lou Chen for MarketWatch. Inflation can be a self-fulfilling prophecy: if people expect higher prices then they demand bigger pay increases, which in turn drives actual prices higher. The longer high inflation lasts the greater the risk that these expectations will become “deeply embedded”. For now the Fed is debating when and how quickly to scale back its $120bn in monthly asset purchases. Actually shrinking the $8.2trn balance sheet of assets it has already amassed isn’t even “on the radar”.  

The Bank of England has been giving clues about how it plans to wind down its own £875bn stock of UK government gilts, says Tommy Stubbington in the Financial Times. “It made the process sound positively serene,” but markets aren’t convinced. Many big investors believe that quantitative easing (QE) is “a thinly veiled scheme to finance the government’s deficit.” Bond markets could take fright if they decide the Bank is withdrawing support too quickly. “Putting the QE juggernaut into reverse” is “likely to be fraught.” 

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