Despite the recent decline in inflation, prices continue to rise in most developed economies, indicating that central banks will need to continue tightening monetary policy in the coming months.
Core inflation rates continued to rise in November and remain well above the 2 percent level that most central banks target, but according to Financial Times data, the share of countries where core inflation is rising has begun to decrease in recent months, although the ultimate goal is still too far away.
Service inflation, another measure of persistent price pressures, remains near its highest levels in several decades in several major economies including the United Kingdom, the United States, and the eurozone.
Tightening Still Makes Sense
Policymakers have aggressively raised interest rates this year in response to rising core inflation measures, but have recently begun to reduce the size of the increases.
Buoyed by optimism that inflation is at its peak, the Federal Reserve, European Central Bank, and Bank of England decided last week to change their strategy in the fight against inflation. While they previously raised rates by 0.75 percentage points, they have now reduced that percentage, with the last increase amounting to 0.5 points.
European Central Bank President Christine Lagarde stated that monetary tightening in the eurozone still makes sense and that policymakers plan to continue raising borrowing costs in increments of 50 basis points in the coming months.
Lagarde also acknowledged that core price pressures have strengthened and will ‘last for some time.’ This message was echoed by Fed Chairman Jerome Powell and Bank of England Governor Andrew Bailey.
Inflation Stronger Than Previously Thought
The initial spike in interest rates, just like the spike in energy and commodity prices, is a consequence of the war in Ukraine and severe disruptions in supply chains. However, rising costs have since become more widespread, in line with high inflation recorded in economies that had shown immunity to price pressures for years.
With the stabilization of commodity prices, overall inflation has sharply fallen in several economies, including the US, UK, and eurozone. Core inflation rates have not followed that example. The most commonly used measure of longer-term price pressures, core inflation, remains at an all-time high of 5 percent in the eurozone.
In the US, service inflation is still at its highest level in the last 40 years, despite a decline in overall inflation of 2 percentage points since the summer.
– Service inflation will be crucial in determining the trajectory of interest rates – said Ben May, Director of Global Macro Research at Oxford Economics.
Fed policymakers acknowledged last week that core inflation will prove to be stronger than previously thought, revising their estimate for next year to 3.5 percent, up from the 3.1 percent forecasted in September.
Service inflation in the UK also remained high, holding in November at the highest rate in the last 20 years, despite a reduction in the overall rate to 10.7 percent from 11.1 percent in October. The Bank of England stated that the persistence of service inflation ‘justifies further strong monetary policy response.’
Many experts argue that while inflation may have peaked, this does not necessarily mean that the path to the targeted 2 percent is now easy.
