The word inflation triggers an automatic negative reaction among many people. Immediately terms such as devaluation and loss of purchase power start swimming around in their head. And rightly so, because a look at any economics textbook will show that inflation, by definition, represents the increase in prices over the period of a year or a month, which means nothing other than that money is losing value. The I word is also unwelcome on the capital markets. Generally an increase in the cost of living is associated with rising interest rates, which in turn is considered toxic for shares.
Nevertheless, inflation is not always something negative. In an expanding economic environment, for instance, a moderate rise in prices is certainly useful. It is not for nothing that the inflation target of the European Central Bank (ECB) is a positive rate of 2%. Even higher rates are accepted on both this side and the other side of the Atlantic, because economists generally consider the risk of deflation – falling prices, in other words – to be the greater problem. Higher prices can, in fact, also have benefits. They give businesses room for investment, which in turn can have a positive effect on productivity and hence on profits as well. It was not until the start of 2020 that the Fed in the USA inaugurated a change in strategy and brought an end to a long monetary policy tradition. The currency guardians, who until then had allowed inflation to peak at no more than 2% before turning the interest rate screw, have since been responding “flexibly”.
So much for the theory. The current inflation trend, however, seems to be causing worry lines to appear on the foreheads of central bankers in the USA. Whereas the inflation rate hovered between 0 and 2% for more than a decade, there has been a steep rise in the curve since 2021. Last year the cost of living rose by an average 4.69% on the previous year, the highest figure for 30 years. Indeed, inflation has actually picked up pace in the last few months: the annual rate of inflation accelerated from 7.9% in February to 8.5% in March 2022, the highest rate since December 1981.
This is a trend that the central bank can no longer ignore. In the middle of March the Fed embarked on a turnaround in interest rates, when the currency guardians hiked the base rate for the first time since 2018. In taking this step, the central bank countered what seems to be runaway inflation for the first time. There is still no sign of inflation easing as rates continue to rise, however, and pressure on the Fed is increasing. Central bank boss Jerome Powell also seems to sense this. He recently surprised the spring conference of the International Monetary Fund (IMF) by mooting a bigger step in interest rates than had been expected. While the market had been reckoning on a further 0.25% rise, Powell brought the prospect of a half percentage point into play: “I would say 50 basis points will be on the table for the May meeting.” This indicates that the central bank is not anticipating a reversal in the rate of inflation any time soon.
Source: tradingeconomics.com
Source: Statista, e = expected
View more information on investment solutions on the topic “Inflation: Galloping upwards”
