In the next few months, there will be an upward blip in inflation, which will temporarily interrupt the free-fall in inflation that started around much of the world during the second half of 2022.
The recent uptick in commodity prices, especially for oil, accounts for much of this ‘blip’ in the easing in inflation.
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On any sober analysis of the inflation outlook, the recent commodity price lift will do little to materially impact the more medium-term pressures for inflation to track towards the broad policy targets for most central banks, including for the RBA.
Growth is still slowing, unemployment rates are still trending higher and supply chain disruptions have been restored.
Just as the inflation surge from 2022 was not an uninterrupted acceleration, month after month after month, nor will the path of lower inflation be uninterrupted.
This matters because central banks and financial markets are now pricing in a strong probability that interest rates will be steady for some time to come, even if there is an off chance of one more hike in the minds of some market watchers. All that the blip in inflation will mean is the scaling back of the timing and extent of interest rate cuts into 2024 and 2025. In other words, the interest rate cuts are now thought to be later and less aggressive, based on the most recent market moves.
The following table shows how inflation has fallen from the peak in a number of countries, with the peak reached in the middle to latter part of 2022. In some instances, where there is more timely data, inflation has ticked up – note the US and Canada in particular.
Oil spike hits inflation
The critical issue in this recent inflation uptick is its cause. Obviously, it is not from excessive demand. Rather - and in the case of oil in particular - it is due to a disruption in output. A number of the large oil producers have responded to the earlier price falls by slashing production, which has created what could be a temporary shortage that has fed through to prices.
This begs an important question for policy makers and markets: would further interest rate hikes dampen this cause of inflation?
The obvious answer, and one well recognised by most sensible central bankers and competent market participants, is an emphatic “no”.
They all recognise there will be a mechanical pass-through of high oil prices to inflation, as is being seen now, but that any further monetary tightening - from an already-restrictive stance for monetary policy - would have a trivial impact.
In other words, don’t grind the economy into an even more troubling hard landing with oppressive rate hikes because of an oil price shock.
Wise heads also know just how fickle oil and other commodity prices can be.
If one or two major oil producers ramp up output, prices could easily revert to where they were just eight weeks ago, which would see inflation fall back sharply. An interest rate hike in those circumstances would not only look silly, it would be the wrong thing to do.
It is also clear that inflation, excluding petrol, is still well contained and will remain so as economic growth tracks below par and the unemployment rate rises.
For now, commodity prices - including for oil - have the attention of markets. It would be no surprise if, in a few months, this storm has passed, oil prices are materially lower and, with that, inflation resumes its downward path.