Why the global fight against inflation is nowhere near over

Federal Reserve Bank Chair Jerome Powell announces that interest rates will remain unchanged during a news conference at the bank’s William McChesney Martin building on May 01, 2024 in Washington, DC. Following the regular two-day Federal Open Markets Committee meeting, Powell said the U.S. economy continues to show momentum and inflation has remained high in recent months, informing the Fed’s decision to keep their current 5.33 percent rate setting.

Don’t mistake the world’s ability to rein in inflation as a permanent victory, a T. Rowe Price analyst wrote for the Financial Times.

“Everyone seems to believe that inflation will return to its boring old normal,” said Chief European economist Tomasz Wieladek. “I disagree. Changes in central bank policy, expectations, labor markets, and globalization mean that inflation will likely stay volatile going forward.”

Still, current inflation levels — close to the 2% target rate for the US and Europe — support market optimism.

However, Wieladek noted that both monetary and fiscal policy works with a lag: down the road, it may turn out that central banks under or overshot their targets. If that happens, this would dent inflation expectations, amplifying future price shocks.

“The degree that policy was overtightened or remains too loose will determine how large this deviation from target will be,” he wrote. “But when inflation persistently deviates from target in the future, central banks will likely act again. Depending on circumstances, this could set the scene for another large inflation target miss.”

Meanwhile, investors should brace for inflation shocks in the years ahead.

Some of the market’s heaviest hitters have made this argument before. For instance, JPMorgan chief Jamie Dimon has repeated warnings of a pricey future, as global militarization and the green transition stoke inflation.

Wieladek pointed to other factors as well.

For instance, tighter labor supply conditions mean that workers have gained greater bargaining power, he noted. As employees demand higher wages, Wieladek expects inflation to become more entrenched.

Meanwhile, although trade openness has helped keep inflation stable, it’s at risk of fading. Globalization is no longer a given in the years ahead, as geopolitical risks come to supply chains, Wieladek said. A potential resurgence of tariffs, as touted by former president Donald Trump, could deepen this trend.

Finally, heavy US investment in AI requires a vast energy expansion, Wieladek noted. As this happens, the US may become a net energy importer.

“This would have adverse inflation consequences for European countries, which rely on US LNG imports,” he wrote. “While AI will likely have a disinflationary effect in the medium term, the associated energy consumption could contribute to higher short-term inflation.”