Mini-WUWS: A cautionary tale of inflation's persistence

In this shorter-than-normal post, let's briefly discuss the latest inflation figures in the US. While the consensus in many economies seems to expect a rapid easing of inflation, the UK is a cautionary tale of its persistence.

Unfortunately, this post will be very short due to work commitments, but I thought it’d be better to briefly comment on this than to skip the post altogether.

Fresh inflation data from the US

In the US, inflation accelerated to 3.7%, but this was mainly driven by higher oil prices, which is reflected in fuel prices at the pump. Fuel prices are wildly influenced by geopolitics. In addition, oil prices are very sensitive to fluctuations in supply and demand. On top of that, higher oil prices today push up inflation now, which leads to a worse reference period in the future. If oil prices have gone down in a year’s time, it will cool down inflation.

Because of this funky volatility, the Fed focuses on core inflation, which excludes fuel and food prices. Core inflation slowed to 4.3%. If the trend over the last three months was annualized, inflation would be 2.4%. It's already promisingly close to the Fed's 2% target, so we'll see if there will be any more rate hikes in America.

When it comes to inflation, you can split hairs endlessly. Nordea's equity strategist has this humorous inflation gauge that strips out almost everything that is even remotely volatile, including used car prices. This gauge shot up on a monthly basis.

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In these posts, I have often talked about how, especially initially, the persistence and speed of inflation could be explained by a slowly updating shelter price level because of its metering methodology. Somewhat eyebrow-raising is that inflation accelerated even though the rise in shelter costs is easing.

In contrast, the Fed's favorite measure, services inflation excluding shelter costs, didn't go anywhere either. Inflation therefore looks resilient, despite a superficial easing. Again, as long as the economy is roaring, the labor market is tight and wages are rising rapidly, it is hard to see the inflationary yoke disappearing permanently.

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In other words, there is data for and against upward pressure on prices, depending on where you want to look.

As I pointed out in my latest post, falling inflation alone does not justify interest rate cuts if the labor market and the economy remain strong. Inflation can also be bouncy, so there's no point in counting your chicks before they hatch.

A cautionary tale of inflation's persistence

The United Kingdom, that has been thrown in the shadows of the global economy after Brexit, may be the exception, or a cautionary tale of what the future holds for inflation and the direction of the economy in other economies.

The UK has been hit hard by the inflation storm. Among the reasons cited are familiar ones such as a shrinking workforce during the pandemic, weak productivity growth, Brexit and higher import prices, and rising energy prices fueled by Russia’s war of aggression in Ukraine. The annual rate of increase in land prices was as high as over 11%. Price rises have slowed by 6% as energy prices have eased, but inflationary pressures remain high, with services inflation continuing to accelerate at over 7%.

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The economy is teetering on the brink of recession. According to recent data, the economy fell by 0.5% in July compared with June. Despite this, the country's central bank has already had to raise its policy rate to more than 5%, as inflation is a greater evil than recession.

With a tight labor market, wages will continue to rise by 6-8%, fueling inflation in a sustainable way.

Optimally, the economy is projected to do somewhat well, with unemployment rising and inflation falling towards the 2% target by 2025. It will be interesting to see in the coming months whether the forecasts come true or whether the persistence of inflation in the island nation continues. It can also tell us about future developments in other economies.

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