The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and Gramercy
June’s awful US inflation numbers are a reminder of tough days ahead for many in America and around the world, and especially the most vulnerable segments of the population and the most fragile developing countries.
This is not because inflation will record yet another four-decade high over the next three months. It won’t. Rather, it is because of the damage already unleashed and that which is to come.
At 9.1 per cent for June, the headline number for US CPI inflation came in well above the median forecast of 8.8 per cent, registering its highest level since 1981. The core measure was also higher than expected and the compositional details added to concerns.
This level of inflation will come as a shock to many, especially those who have been falsely comforted by a US Federal Reserve narrative that, from day one of this inflation episode, has failed to understand the dynamics in play, grasp the seriousness of what’s ahead, and act promptly and decisively to avoid undue harm to so many.
The stunning number, which will be splashed across the front pages of newspapers and dominate news shows and websites, will further erode the already-damaged policy credibility of the Fed and undermine the effectiveness of its all-important forward guidance tool.
And this is a Fed that, unlike the European Central Bank, is yet to explain why it has forecast inflation so wrong for so long; and unlike the Bank of England, is yet to play the technocratic role of an honest adviser on what is going on in the economy and why.
The Fed now has no choice but to respond aggressively. It is sure to increase interest rates by 0.75 percentage points later this month and could well consider a 1 percentage point rise.
Such a belated policy reaction will increase the risk of a recession, especially given that economic activity is slowing. This adds the curse of income insecurity to the serious erosion in purchasing power caused by inflation — phenomena that hits the low income earners particularly hard.
Fortunately, inflation will come down over the next three months. That’s the good news. Less good is the continued broadening of price pressures that was evident in today’s detailed data. That adds to the considerable uncertainty that surrounds the stickiness of an inflation process that the Fed has allowed to get more entrenched into the economy.
As such, and especially if the Fed fails to get its act together quickly, it would be foolish to dismiss the chance of a third wave of inflationary pressures that would interrupt and reverse the downward movement of the next three months.
The implications of all this go well beyond the US. This high inflation, and the monetary policy reaction it will entail, will add fuel to the phenomenon of “little fires everywhere” and is particularly worrisome for developing countries already dealing with food and energy insecurity.
They now face a further tightening of global financial conditions, as well as increased dollar appreciation that aggravates their imported inflation and risks destabilising their debt sustainability and the domestic financial markets.
Have no doubt: the latest inflation numbers are indicative of rough seas ahead, particularly for the most vulnerable segments of society in the US and around the globe. And to think that much of this could have been avoided had the world’s most powerful central bank been more responsive with its policy tools — and not stuck so doggedly to its stance that inflation rises last year were just “transitory”.
