With inflation in most advanced economies rising at a rapid pace since mid-2021, the most important central banks have been raising interest rates intensely and in some cases making it clear that the priority is to return to price stability, even if at the expense of growth. In several economies, we are already seeing signs of a slowdown, commodity prices have been falling and some yield curves are already pricing in a loosening of monetary policy in 2023.
Do we already have evidence that inflation will return to low levels and, consequently, can we expect less harsh messages from central banks?
In previous articles, I dealt with structural factors that could lead to higher inflation levels in the coming years, such as the effects of a possible downturn in the globalization process, changes in the labor force participation rate, the search for alternative energy sources , between others. In this article, the focus is on the analysis of the current stage of the economic cycle and its impacts on the outlook for growth in the coming quarters.
The most important factor for measuring the phase of the cycle is the state of the labor market. In this aspect, the US emerges as the most heated economy in the world and at high risk of having current inflationary pressures carried into the future.
Last Friday (5), the data released was surprisingly strong. There are still around 11 million vacancies and less than 6 million unemployed. Even the sectors most sensitive to rising interest rates, such as real estate and durable goods, continue to employ at a strong pace. The combination of the lowest unemployment rate in 50 years with rising wages has supported household income and prevented a more significant drop in consumption, even with inflation acting in the opposite direction.
In Europe, the labor market situation is far from the American strength, but salary readjustments have not felt the slowdown in economic activity. The fact is that, after so long of high inflation, prices and wages begin to react to past inflation, and inertia appears.
Global financial conditions are more restrictive, and there are clear signs of a slowdown, especially in the industrial sector – where inventories are already starting to normalize. However, the rise in interest rates does not seem sufficient (real interest rates remain negative in most developed countries) to impact services further. It may be that demand is still being sustained by the post-pandemic reopening, but the fact is that in this sector, in general, there are no signs of inflationary relief.
On the other hand, as a factor of lower inflationary pressure we have the reestablishment of production chains, impacted by the pandemic and the war. For the first time in two years, indicators that measure disruptions in the supply of industrial inputs and food have shown signs of normalization. This relief may help to decelerate inflation, but will it be enough to bring it back to levels close to the targets? Most likely not, if the job market remains very strong.
As with any other tightening cycle, there is a lot of uncertainty about how much further interest rates will need to be raised and, consequently, how much of the necessary slowdown in activity will be. However, there is a particularity of the current moment that makes the process even less predictable.
Most central banks erred in the diagnosis that inflation would be temporary, taking time to react even when inflation was already widespread and more persistent, putting their credibility at risk. Today, expectations for medium and long-term inflation are under control, but the danger of de-anchoring is not small.
Faced with a very undefined scenario, it is likely that central banks will continue to act vigorously. While markets believe there will be a soft landing for major economies, the mood changes fast. Everything will depend on how the ongoing slowdown will impact the labor market and wage formation, as well as the reactions of central banks that have their credibility on the line.
I have over 8 years of experience in the news industry. I have worked for various news websites and have also written for a few news agencies. I mostly cover healthcare news, but I am also interested in other topics such as politics, business, and entertainment. In my free time, I enjoy writing fiction and spending time with my family and friends.
