A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK.
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.
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