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Category: Bullion Bulletin

Bullion Bulletin: The inflation dilemma

US inflation was more than 9% in June, which sounds bad enough – the highest it's been in more than 40 years – but within that headline figure the...

31 July 2022

Gary Mead

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US inflation was more than 9% in June, which sounds bad enough – the highest it’s been in more than 40 years – but within that headline figure there are many worse: over the past 12 months gasoline has gone up in price by more than 60%, airline fares (America is a big country) by more than 40%, and food prices – which hit the poorest hardest, and they spend a proportionately bigger amount of their income on food – have soared. Eggs are up 33%, chicken by almost 20%, milk by more than 16%, butter and margarine by more than 26% and coffee by almost 16%.

This is not merely a cost-of-living horror. It also draws into question the reliability of the guidance and control over price policy of the world’s most important central bank, the Federal Reserve. All last year, the official line of the Fed was that inflation was ‘transitory’. That was wrong, and many stated that it was wrong at the time. So why should we now give the Fed any credit when it claims it can bring inflation under control?

Having fallen behind the inflation story, the risk is that the Fed will now act with considerable aggression when it comes to the main tool it has for putting out inflation’s flames – interest rate rises. And that this will induce a recession not just in the US but elsewhere. The European Commission has cut its forecast for Eurozone economic growth, to 2.6% and to 1.4% for 2023 and revised higher its inflation expectations, to 7.6%, for this year. The Commission says that the “rapid increase in energy and food commodity prices is feeding global inflationary pressures, eroding the purchasing power of households and triggering a faster monetary policy response than previously assumed. Furthermore, the deceleration of growth in the US is adding to the negative economic impact of China’s strict zero-Covid policy”.

The Federal Funds Rate – the main reference for interest rates in the US – is currently 1.5% to 1.75%. And that means interest rates are still around 7% negative real. The betting is now that the Fed will this month raise the rates by 0.75%-1%. “Such a belated policy reaction will increase the risk of a recession, especially given that economic activity is slowing”, says one commentator, but that voice stands for many.

Central bankers are facing the trickiest task imaginable – to control inflation (and put up interest rates high enough, much higher than now) they must decide whether the inflation we have is running out of steam. If it is then they can afford to relax a little, live with the high price explosion, and wait to inflation to die away. Crude oil prices, which underpin the costs of many sectors, fell back to their level prior to Russia’s invasion of Ukraine on 14 July, as fears of a recession cut demand; data from the US Energy Information Administration suggested gasoline demand had slipped to its lowest level for the time of year since 1996. This plays somewhat into the “inflation is transitory” narrative – it’s transitory but only in the sense that a stopped clock tells the correct time twice a day. Yet if inflation proves much stickier, companies continue to struggle to fill job vacancies, and demand does not substantially drop away, to not raise interest rates risks laying the ground for a much bigger economic crack-up in the future.

But if the US is already slowing, as parts of the country’s economy already is, then to tighten credit and make money more expensive by pushing rates up runs the risk of tipping the US from a slowdown into an outright recession. The Federal Reserve was wrong-footed last year, and this year it might prove to be utterly legless.

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