Has the world conquered inflation?

Bravo to the central bankers, says The Economist . The likes of the Bank of England and the US Federal Reserve appear to have pulled off mission impossible – bringing down inflation without crashing the economy. In 2022 the average rate of inflation across developed countries peaked at about 10%. Large interest rate hikes followed and inflation in most developed economies has now fallen below 3% (annual UK inflation was 2.2% in July).

Previous central banks’ battles with inflation tamed prices only at the cost of “deep” recessions. While the going has been tough this time, severe pain has been avoided. Interest rate theory worked in practice, with hikes causing just enough cooling in labour markets to ease wage pressure, but not so much that they triggered mass unemployment.

Are central banks the reason that inflation is lower?

A recent central bankers’ summit at Jackson Hole verged on the “self-congratulatory”, says Martin Sandbu in the Financial Times . Financial elites gathered in the Wyoming wilderness and patted each other on the back. They believe central banks deserve a decent share of the credit for defeating inflation. Yet there are holes in this self-serving narrative.

For one thing, interest rate rises don’t magically cool down hiring. Businesses only hire less when they first see actual weakness in the economy. While the picture has been a little different in Europe, US growth has been so strong of late there is little evidence that this is what actually happened. Recent shifts in the labour market may just be things returning to normal following a period of intense disruption following the pandemic. With the job largely done, the Fed is “all but guaranteed” to cut US interest rates later this month, says Paul Krugman in The New York Times . US consumers’ expectations of future inflation peaked in the summer of 2022 and have since returned to pre-Covid levels.

While Kamala Harris will struggle to convince voters the Democrats have actually “done a good job managing the economy”, surveys show the economy slipping down voters’ lists in favour of other priorities. Inflation is “fading away – not just in the data, but also as a political issue”. In the UK, investors are licking their lips at the prospect of more Bank of England rate cuts to end the year, says Liam Halligan in The Telegraph . Cheaper borrowing would also ease the size of the Treasury’s “gargantuan debt-service bill”. The optimism could be misplaced.

Inflation looks set to tick up slightly over the coming months, boosted by a £149 rise in the average household energy bill this October. Geopolitical chaos could blindside us again with another inflationary shock, not to mention recent “inflation-busting trade union pay” agreements. “Inflation is by no means tamed.” It “could even return with a vengeance”.

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