Getting back to low inflation

03 April 2023

Across the world, inflation has been running ahead of expectations ever since 2021. But the tide seems to be turning.

The US is leading the way, with inflation down from last year’s peak of 9.1% to 6.0% in February. Lower commodity prices, especially energy prices, are feeding through to US consumers. Post-pandemic supply chain and inventory problems have eased and with them the shortages of goods that drove inflation. A year ago goods price inflation in the US hit an all-time high of 19%. Price pressures have faded since then and in February goods prices were 1.8% lower than a year earlier.

Inflation has moderated in the euro area too, though more gradually than in the US. Headline inflation has fallen from a peak of 10.6% last October to 6.9% in March. Goods price inflation is slowing and energy prices are lower than a year ago.

Inflation is proving stickier in the UK. Headline inflation is running at 10.4%, not far off its peak rate. Unlike the US and the euro area, goods price inflation remains high and energy prices are rising.

Still, in the UK, as in the US and the euro area, headline inflation is likely to fall back in the next few months. Economists are counting on weaker growth, a normalisation of supply conditions and lower commodity prices to deliver a big fall in inflation rates. On average economists see inflation in the US, euro area and the UK dropping to around the 3.5% mark by December.

We’ve seen similar hopes dashed before. This time last year most forecasters expected inflation to fall, instead, it surged. Having been blindsided by the worst outbreak of inflation in 40 years, central banks are not complacent. Agreed, a lot of the one-offs that drove inflation, from supply chain problems to roaring commodity prices, are going into reverse. But central banks worry that the buoyant services sector, wage growth and corporate pricing power could mean that inflation becomes entrenched.

Only the hard inflation data will tell us whether inflation is fading or has become stuck in the system. If central banks don’t see a marked easing of inflation pressures, they are likely to raise interest rates to weaken growth. One way or another inflation is likely to fall, the question is whether achieving this will require central banks to push their economies into recession. In the past, when inflation has reached the sort of level we’ve seen in the last year, recessions have ensued.

Yet the pandemic and its inflationary aftermath were exceptional and so, too, the logic runs, will be the resolution of the current bout of inflation. Markets and economists are expecting policymakers to pull off quite a feat, taming inflation without collapsing growth. The general view is that growth will be sluggish or, at worst, there will be mild recessions and that the US, the euro area and the UK will avoid the hard landings that were seen in previous inflationary outbreaks.

For once a Goldilocks outcome, a relatively soft landing for the economy, is the most likely outcome. But it’s not assured.

For the latest charts and data on health and economics, visit our Economics Monitor:
https://www2.deloitte.com/uk/en/pages/finance/articles/covid-19-economics-monitor.html

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 3.1% at 7,632. Equities gained last week as concerns about the banking system eased.

Economics

US money market funds saw a record inflow of $66bn last week following the collapse of Silicon Valley Bank and Signature Bank
US banks increased the use of the Fed’s new lending facility by $10bn last week, taking the total size of the programme to $65bn
Boston Fed president Susan Collins revealed that she expects the US Fed to implement one more 25bp rate rise despite uncertainties about the state of the financial system
US president Joe Biden called on banking regulators to increase supervision and regulation of mid-size banks, following the collapse of SVB
US house prices dropped for a seventh straight month in January
US weekly jobless claims increased to 198,000 last week signalling that the labour market may have started to cool
UK real GDP grew by 0.1% in the final quarter of 2022, stronger than previously estimated and suggesting a degree of resilience in the economy
UK house prices have fallen every month since August by a total of over 6.1%, according to the Nationwide
Grocery inflation in the UK hit 17.5% in March, the highest since records began in 2008, according to Kantar
The UK government’s plan to increase the pension age to 68 was scrapped due to falling life expectancy
The UK has signed a trade pact with 11 Asia and Pacific nations, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). The CPTPP was established in 2018 and includes Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam
Eurozone annual inflation fell to 6.9% in March driven by a fall in energy prices, a bigger decline than expected by economists
In a sign of a rebound in growth, Chinese non-manufacturing activity expanded at the fastest monthly rate in 12 years in March

Business

German companies invested a record €11.5bn in China last year with a third coming from the big automakers VW, BMW and Mercedes-Benz, as well as chemical group BASF
Wall Street average bonuses fell by over a quarter last year driven by low deal-making transaction values
Asda’s profits fell by almost 25% in Q4 2022 after the supermarket decided to cut prices amid the cost-of-living crisis
The UK government announced plans to classify nuclear energy as a green investment
Italian legislators announced a proposal to split retail and investment banking to reduce systematic risks in the economy

Global and political developments

Former US president Donald Trump was indicted by Manhattan prosecutors; the details of the charges are yet to be confirmed
Finland was cleared to join NATO after Turkey ratified its membership, despite months of uncertainty
US secretary of state Antony Blinken expressed his concerns about Russia’s detention of The Wall Street Journal reporter Evan Gershkovich
The European Commission announced that it would wait an additional month to determine whether Italy met the objectives needed to unlock its next €19bn trance of the EU-founded COVID recovery plan
Humza Yousaf won the SNP’s leadership race and became Scotland’s first minister

And finally… a cheese-themed luxury spa is set to open its doors in Madison, Wisconsin, offering a variety of high-end cheese therapy such as fondue facials – Gouda times

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