It is one of the most contentious questions in world economics: what exactly is happening with inflation? There are signs that the inflation rate is picking up as economies start to gather speed as restrictions ease, boosted by fiscal and monetary stimulus. The issue is particularly contentious in the US, where the latest figures show the core annual inflation rate – which excludes volatile food and energy costs – rose to 3.1 per cent in April, its highest rate since the 1990s.
There are once-off factors at play here, not least the the impact of the pandemic restrictions on last year's data. The US Federal Reserve board has also indicated that the restart after the pandemic and the impact from budget stimulus and supply chain disruption may create once-off inflationary pressures, which will ease later in the year. The ECB's chief economist Philip Lane has made the same point about the euro zone inflation rate, which has also accelerated – although, at 1.6 per cent, it remains below the ECB target.
Relaxed approach
The central banks may well be correct that the rise in inflation is temporary – and so far financial markets have taken a relatively relaxed approach. But we just don’t know. The economic impact of the pandemic has been unprecedented and the pace of the recovery may be sharp – and bumpy. As many businesses in Ireland will tell you, supply chain disruptions have been significant and price pressures are being faced by many sectors.
Whether these are temporary or permanent factors remains uncertain. But it will have a big impact on the future trend in inflation – and interest rates. The Fed has said it stands ready to react if there is any permanent increase in the inflation rate above its 2 per cent target. In turn, this has massive implications for financial markets across the world, with long-term interest rates already starting to edge upwards. The most well-known economists in the US are divided on what happens next. Some believe US president Joe Biden’s $6 trillion budget plans risk overheating and boosting inflation while others say they are entirely appropriate.
A lot hangs on which side of this argument is correct.
