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Central bankers have sounded the alarm over the threat of fresh outbreaks of inflation, warning of the effect of deep “scars” on households from the post-pandemic price upsurge.
The Bank for International Settlements found that households in 29 advanced and emerging market economies expected inflation over the next 12 months to be about 8 per cent, far higher than the current 2.4 per cent average inflation level.
This raises the threat that price expectations become “unmoored” from central banks’ official inflation targets, with households and groups responding precipitously to future jumps in prices by demanding higher wages and jacking up prices in a self-reinforcing spiral.
“Households are very much influenced by the recent inflation experience; when it comes to inflation expectations, it’s once bitten, twice shy,” said Hyun Song Shin, head of the Monetary and Economic Department at the BIS.
“It is well-known that surveys of households’ inflation expectations tend to overestimate real inflation. But if those perceptions then translate into actions and their behaviour, that’s going to impact the economy.”
Central banks around the world have been trimming interest rates as the worst price surge in a generation subsides. Inflation in advanced economies is set to drop to 2.2 per cent next year, far below the high of more than 7 per cent in 2022, according to IMF forecasts. In emerging economies inflation will drop to 4.6 per cent compared with just under 10 per cent that year.
But officials remain on edge given the lasting legacy of the inflationary upsurge after the end of the Covid-19 restrictions, which was exacerbated in many economies by energy price jumps that followed the Russian full-scale invasion of Ukraine as well as gains in other commodity values.
President Donald Trump’s trade war has added a new threat, especially in the US, where the Federal Reserve has kept policy on hold this year given the possibility that increases in tariffs to the highest levels in decades drive up consumer prices.
The Basel-based BIS, which advises the world’s central banks, argued that while temporary jumps in inflation were often viewed as being “relatively benign”, there was a risk they would lead to persistent increases in inflation fed by upward shifts in expectations.
It found in its annual report that additional forces, such as population ageing, climate change, geopolitical tensions and a less elastic supply side, could all contribute to a more volatile environment, making policymaking more fraught for central bankers.
“Households, in particular, may show less tolerance for price increases and real wage declines following the sharp rise in living costs after the pandemic,” warned Agustín Carstens, general manager of the BIS.
“If evidence of de-anchoring emerges, central banks must respond quickly and forcefully to inflationary shocks. The uncertainty surrounding the timing, magnitude and future trajectory of tariffs further complicates this task.”
Fed chair Jay Powell has highlighted the risk that people’s memories of post-Covid inflation could complicate the US central bank’s efforts to stamp out price pressures.
Powell said on Wednesday that US rate-setters had been more sure that tariffs would prove a one-off shock back in Trump’s first term.
This time around a one-time shock remained “the base case”, the Fed chair told the Senate banking committee. But he added that given the legacy of the global inflation increase, the threat of a more prolonged bout of tariff-induced price pressures was “something you want to approach carefully in a world where inflation is not back to 2 per cent”.
Households’ expectations of inflation shot up following Trump’s unveiling of his “reciprocal” tariffs on April 2, with the University of Michigan’s closely watched polls of short-term and longer-term inflation expectations hitting highs last seen in the early 1990s.
They have since declined following the ratcheting down of trade tensions between the US and China, but they remain at levels that are more than double the Fed’s 2 per cent goal. The Fed has stressed that market-based measures have continued to show that inflation expectations among US investors remain well anchored.
In its latest meeting earlier this month, the Bank of England also flagged risks surrounding “elevated” household and business inflation expectations, with worries about an oil shock stemming from the Middle East conflict adding to the reasons to be alert.
