Inflation could stay much higher for longer due to the “canned heat” of loose monetary and fiscal policy and a new attitude from central banks, according to a number of investors.
Konstantinos Venetis, director of global macro at consultancy firm TS Lombard, said there was considerable downward pressure
But he believes the pressures on the banking system in the US, which would be exacerbated by a recession, mean central bank focus, which has so far been entirely focused on reducing inflation, could switch to being more worried about achieving financial stability.
If that shift in focus happens then the likelihood is interest rate rises would either be paused early to preserve liquidity in the financial system and reduce debt defaults or interest rate cuts could be brought forward.
Either scenario would have a material impact on inflation expectations in the economy, and potentially drive inflation higher.
He describes this as just one of the potential range of economic outcomes, and adds that uncertainty in the banking system also increases the chances of a recession as banks reining in lending has much the same effect as higher interest rates, but likely happens at a faster pace.
David Jane, multi-asset fund manager at Premier Miton, is another who sees potential for inflation to stay higher for longer.
He says: “Historically, inflation at current levels has rarely been a purely transitory problem, once prices rise by a certain degree they tend to continue to rise rapidly for a period of years. This is a dual consequence of business and consumer behaviour changing to adjust to rising prices and government actions to mitigate inflation impacting on certain targeted groups.
Pressure points
"At present workers appear to have a very strong negotiating position, as current levels of demand and a reducing labour force mean that labour shortages persist in most western economies. This means that wages are growing strongly, although in many cases not as fast as CPI inflation.
"This will only change in the case that the economy slows materially, to the point that there is excess labour again. Basically, unemployment will rise enough to ease wage cost inflation in the event of a recession.
"Despite rising prices, consumers balance sheets are still strong, at least in the US, where most mortgages are long term and on fixed rates. One possible, disinflationary, impact might be a material fall in house prices and rents, as higher interest rates bite into house prices.”
The key role of consumer and business sentiment in the trajectory of inflation was recently highlighted by the Bank of England chief economist Huw Pill who, in a speech in Geneva, said monetary policy actions on their own cannot control inflation.
