Dan Farmer
Changing sources of inflation
While inflation remains far too high, the sources of inflation have changed.
Global supply chains are no longer overwhelmed by surging demand for goods, nor disrupted by COVID-19.
Think back to the first half of last year; there were stories of strong demand for everything from furniture to games consoles. Demand for these items and other goods has cooled.
Remember the global microchip shortage that was frustrating so many industries last year? That has eased too.
The oil price today is lower than before Russia’s invasion of Ukraine.
So, why is inflation providing to be so sticky?
The main source of inflation now is in service industries, which are more exposed to labour costs. In the US, Britain, Canada, and New Zealand, for example, wages are still growing with the need for labour still strong – six of the G7 group of big rich countries are currently enjoying an unemployment rate at or close to the lowest seen this century.[1]
It is hard to see how underlying inflation can meaningfully ease while labour markets are so strong. So households, businesses, and investors are likely going to have to navigate further interest rate rises and the accompanying complications and hardships.
Central Banks to the rescue?
Over the past few decades, investors became accustomed to central banks coming to the rescue by cutting official interest rates to give financial markets a boost when things got jittery.
This time, though, it is hard to imagine. Commentary from the Fed, as well as other major central banks, including the Reserve Bank of Australia, suggests that official interest rates will keep rising until inflation is brought under control.
Wishful thinking — seen in events like the very strong start to January across many share markets, on the back of investors appearing to have temporarily convinced themselves that the rate rising cycle was nearing an end — is unlikely to alter central banks’ inflation fighting, interest raising course.
The thing about inflation is that it is difficult to haul back once it gathers a head of steam as we saw when the Fed’s preferred inflation gauge rose again in January, the fastest pace since June last year.
By Dan Farmer, Chief Investment Officer
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