Rising inflation trends are putting a squeeze on central banks

Sometimes events have their own natural flow and after noting yesterday that the winds of change in UK inflation are reversing we have been reminded twice already today that the heat is on. First from a land down under where inflation expectations have done this according to Trading Economics.

Inflation Expectations in Australia increased to 4.20 percent in June from 3.70 percent in May of 2018.

This is significant in several respects. Firstly the message is expect higher inflation and if we look at the Reserve Bank of Australia this is the highest number in the series ( since March 2013). Next  if we stay with the RBA it poses clear questions as inflation at 1.9% is below target ( 2.5%) but f these expectations are any guide then an interest-rate of 1.5% seems well behind the curve.

Indeed the RBA is between a rock and a hard place as we observe this from Reuters.

Australia’s central bank governor said on Wednesday the current slowdown in the housing market isn’t a cause for concern but flagged the need for policy to remain at record lows for the foreseeable future with wage growth and inflation still weak.

Home prices across Australia’s major cities have fallen for successive months since late last year as tighter lending standards at banks cooled demand in Sydney and Melbourne – the two biggest markets.

You know something is bad when we are told it is not a concern!

If we move to much cooler Sweden I note this from its statistics authority.

The inflation rate according to the CPI with a fixed interest rate (CPIF) was 2.1 percent in May 2018, up from 1.9 percent in April 2018. The CPIF increased by 0.3 percent from April to May.

So Mission Accomplished!

The Riksbank’s target is to hold inflation in terms of the CPIF around 2 per cent a year.

Yet we find that having hit it and via higher oil prices the pressure being upwards it is doing this.

The Executive Board has therefore decided to hold the repo rate unchanged at −0.50 per cent and assesses that the rate will begin to be raised towards the end of the year, which is somewhat later than previously forecast.

Care is needed here as you see the Riksbank has been forecasting an interest-rate rise for some years now but like the Unreliable Boyfriend somehow it keeps forgetting to actually do it.

I keep forgettin’ things will never be the same again
I keep forgettin’ how you made that so clear
I keep forgettin’ ( Michael McDonald )

Anyway it is a case of watch this space as even they have real food for thought right now as they face the situation below with negative interest-rates.

Economic activity in Sweden is still strong and inflation has been close to the target for the past year.

US Inflation

The situation here is part of an increasingly familiar trend.

The all items index rose 2.8 percent for the 12 months ending May, continuing its upward trend since the beginning of the year. The index for all items less food and
energy rose 2.2 percent for the 12 months ending May. The food index increased 1.2 percent, and the energy index rose 11.7 percent.

This was repeated at an earlier stage in the inflation cycle as we found out yesterday.

On an unadjusted basis, the final demand index moved up
3.1 percent for the 12 months ended in May, the largest 12-month increase since climbing 3.1 percent in January 2012.

In May, 60 percent of the rise in the index for final demand is attributable to a 1.0-percent advance in prices for final demand goods.

A little care is needed as the US Federal Reserve targets inflation based on PCE or Personal Consumption Expenditures which you may not be surprised to read is usually lower ( circa 0.4%) than CPI. We do not know what it was for May yet but using my rule of thumb it will be on its way from the 2% in April to maybe 2.4%.

What does the Federal Reserve make of this?

Well this best from yesterday evening is clear.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

If we start with that let me give you a different definition of accommodative which is an interest-rate below the expected inflation rate. Of course that is off the scale in Sweden and perhaps Australia. Next we see a reference to “strong labo(u)r market conditions” which only adds to this. Putting it another way “strong” replaced “moderate” as its view on economic activity.

This is how the New York Times viewed matters.

The Federal Reserve raised interest rates on Wednesday and signaled that two additional increases were on the way this year, as officials expressed confidence that the United States economy was strong enough for borrowing costs to rise without choking off economic growth.

Care is needed about borrowing costs as bond yields ignored the move but of course some may pay more. Also we have seen a sort of lost decade in interest-rate terms.

The last time the rate topped 2 percent was in late summer 2008, when the economy was contracting and the Fed was cutting rates toward zero, where they would remain for years after the financial crisis.

Yet there is a clear gap between rhetoric and reality on one area at least as here is the Fed Chair.

The decision you see today is another sign that the U.S. economy is in great shape,” Mr. Powell said after the Fed’s two-day policy meeting. “Most people who want to find jobs are finding them.”

Yet I note this too.

At a comparable time of low unemployment, in 2000, “wages were growing at near 4 percent year over year and the Fed’s preferred measure of inflation was 2.5 percent,” both above today’s levels, Tara Sinclair, a senior fellow at the Indeed Hiring Lab, said in a research note.

So inflation is either there or near but can anyone realistically say that about wages?

Mr. Powell played down concerns about slow wage growth, acknowledging it is “a bit of a puzzle” but suggesting that it would normalize as the economy continued to strengthen.

What is normal now please Mr.Powell?


One of my earliest themes was that central banks would struggle when it comes to reducing all the stimulus because they would be terrified if it caused a slow down. A bit like the ECB moved around 2011 then did a U-Turn. What I did not know then was that the scale of their operations would increase dramatically exacerbating the problem. To be fair to the US Federal Reserve it is attempting the move albeit it would be better to take larger earlier steps in my opinion as opposed to this drip-feed of minor ones.

In some ways the US Federal Reserve is the worlds central bank ( via the role of the US Dollar as the reserve currency) and takes the world with it. But there have been changes here as for example the Bank of England used to move in concert with it in terms of trends if not exact amounts. But these days the Unreliable Boyfriend who is Governor of the Bank of England thinks he knows better than that and continues to dangle future rises like a carrot in front of the reality of a 0.5% Bank Rate.

This afternoon will maybe tell us a little more about Euro area monetary policy. Mario Draghi and the ECB have given Forward Guidance about the end of monthly QE via various hints. But that now faces the reality of a Euro area fading of economic growth. So Mario may be yet another central bank Governor who cannot wait for his term of office to end.



19 thoughts on “Rising inflation trends are putting a squeeze on central banks

  1. The slight rise in inflation is just a temporary blip, the end of cycle rise in the oil price and currency movements are mainly to blame. See 2007/8. Raising rates now would be mental. It’s too late.

    In the medium term inflation will fall back again without central banks doing anything.

    In fact raising interest rates will actually increase inflation in the medium and long term. Traditional central banking theory based on the Philips Curve is utterly and completely wrong. See Japan and every other country which has followed ZIRP.

    The economic cycle will come to an end in the next 6-12 months and there will be a recession. It’s likely to be hardest in Australia, China and in the Eurozone (mainly because of the Euro). The US will go in last and likely be less affected; with the exception of their bubbly stock markets. The UK will probably be somewhere in between the US and EU.

    Most western countries will end up in a similar situation to Japan IMO. Huge public debt (automatic stabilisers and the nationalisation of banking systems), near zero or even negative government bond yields and near zero inflation. The exception is the Euro area and it remains to be seen what the political reaction will be to the next downturn and increasing deficits and public debt that will occur.

    • Hi David

      You mention of a recession on its way is something we have been discussing on here with relation to the slowing of the monetary numbers in the Euro area and UK. They have been signalling a slow down as we wait to see how much.

      Interestingly Mario Draghi covered his bases somewhat at the ECB Presser earlier. This was because he slid in the word “weak” several times and then used it with “strong” and “balanced” thus heading into my financial lexicon for these times.Also I noted that he called 0.4% quarterly GDP growth “strong” too so is he warming us up fr something less?

  2. Central banks are trapped by their own policies, which are impossible to reverse since governments let alone banks would be rendered insolvent and there would be a sovereign debt crisis in many countries as their deficits exploded and their currencies collapsed.

    The Fed has many reasons to keep raising rates, the first is so that they can lower them when the recession comes(yes its insane, since the very increases in interest rates will cause the recession they will then have to cut rates to avoid, but that is wht they are doing it.)

    They are also aware of the looming pension crisis, with many state pension funds insolvent, that have had to invest massively in bonds with low single digit yields when the actuaries running them are assuming long term returns of around 8%. The fact that putting up rates will cause massive losses on those very bond portfolios is as obvious as the damage higher rates will do to overindebted consumers and companies that have leveraged their balance sheets up with cheap debt to finance share buybacks.

    Getting back to Europe, Draghi has a bit of a dilemma with Italy if he tapers QE, and the Italian government has a bit of a dilemma issuing bonds if the ECB stops buying them, Italian 10 year yield is currently 2.9%, if the ECB wasn’t buying all of it, who would buy Italian debt when the US 10 year yield is exactly the same?

    • Hi Kevin

      It turned into an interesting day with the ECB announcing another QE taper to 15 billion Euros a month in September then 0 from December. But backed up with something I have been pointing out for a while that Mario has no intention of raising interest-rates in his term which gets us to October 2019. What we did discover was something that got the Euro to drop by 1.7% ( as I type this) to below 1.16 versus the US Dollar. Although in the end it may not have been all Mario…..

  3. I think the Fed is doing exactly the right thing. The rate rises are small so haven’t affected market rates much but the fact that rates are going up is sending a very clear message to prospective borrowers and should, gradually, rein in the borrowing. If only the BoE would pluck up the courage to follow suit.

    • Hi DoubtingDick

      If anything like the scenario described by David takes place then I fear the Bank of England will take Bank Rate negative. This will of course be completely unexpected and nobodies fault unless they can find somebody minor to blame.

  4. Hi Shaun, thanks for highlighting the property falls in AUS. I did not know but it seems to be a new global paradigm once the respective estate bubbles have met their zero lower bound peaks.

    It seems that real estate is falling in London, Canada, AUS and likely Italy. Maybe we are near an inflection point.

    Thanks Paul

    • Shaun remarked the other day about a block of flats near him with little sign of life. Flats are usually the first sector to fall significantly as potential buyers start to look at small semis instead.

    • From yesterday’s New Zealand Herald –
      ” But Auckland prices continue to fall, down 1.3 per cent from $862,800 to $852,000 in the year to May, with volumes also down. ”

      Nationally prices are rising by about 5% annually so the fall in average values is restricted to Auckland.

  5. Hello Shaun,

    Rising inflation and the Banks ?? I thought it was just last Tuesday the CB were wanting higher inflation ? or is it like all the other examples of “forward guidance” ? ie a load of cobblers?

    inflation , either by IR hikes or by oil hit the man/woman in the street , the Banks are all bust anyway so I don’t see them changing – they have the backing of governments, so whats a little more tax payers cash ?

    if there’s a major asset fall I do expect the stops will be pulled and the spinning plates will get jet powered assistance ! ( along with ten league boots to kick the can …..)


    • Hi Forbin

      What was that about being careful what you wish for? As soon as the central bankers get what they said they want they wont want it! Meanwhile that poor battered can is being kicked further than ever Eliiot Daly can manage.

  6. Another interesting example from Oz to put alongside playing Monopoly to show that it is the cost and availability of credit, which determines house prices, not the level of immigration (Oz takes twice as many as we do relative to population).

    Although oil prices have peaked and may fall a bit, it would only take trouble in Venezuela or the ME to send it rocketing. The GBP has only picked up today on expectations that higher retail figures will prompt the “unreliable boyfriend” to raise rates. That will soon evaporate as house prices here have certainly levelled off, so the GBP price of oil will rise further, putting further pressure on consumption.

    It does seem that we are about to reach a turning point – low rates to encourage borrowing simply mean that consumption has been brought forward from the future, so that the 2018 consumption brought forward by a decade has now been reached in time and some of that normal consumption has thus already disappeared. Should we be at the end of a cycle and recession strike in a Japanese way, it will not just be the half a million retail jobs that disappear by 2025.

    • Seems the local agent for the BoE is only coming to Glasgow -still, not far on the train ….

      I will have to ask (alongside my long-standing nomination for Governor) about howthey have got it all so spectacularly wrong and ignored the example of what has already happened in Japan.

  7. At the risk of being controversial I think basic economics is broken because too much of profits is going to shareholders and otherwise concealed in tax havens. There can be no other explanation apart from every figure provided by the entire worlds statistical authorities are falsified in the same direction which is a tad unlikely.

    I think the simplest action that can be taken is country by country reporting and a clampdown on tax havens although I won’t hold my breath for either.

    • Hi bill40

      There also needs to be a clamp down on countries which have touted for such business like Ireland via lower corporation tax rates and tax free zones in Dublin. It is not hard to spot as the gap between GDP and GNP is a signpost.

    • “There can be no other explanation apart from every figure provided by the entire worlds statistical authorities are falsified in the same direction which is a tad unlikely.”

      Is it?

      Have any statistical authorities introduced measures which happen to increase the reported level of inflation? Indeed the biggest deflationary measure yet taken could be the fiddling of the figures. Hamsters being vital goods and the inclusion of emerging products, which always see deflation, trumpeted and praised by troll armies from within those statistical authorities.

      When zombie banks have to eat their own customers to stay afloat one might think something were amiss.

  8. Great blog as usual, Shaun.
    As you say the US Fed doesn’t target the CPI-U, but the PCEPI. Its annual inflation rate was 1.97% in April, unchanged from March. (While it may not be very meaningful to report inflation rates to the second decimal point, this is how the St. Louis Fed database references them; the annual inflation rate for the PCEPI hasn’t been at or above 2.00% since February 2017 (2.18%), so there have been multiple increases in the federal funds rate while the target inflation indicator has been below target.
    During the press conference, Chairman Powell gamely insisted that the 2.0% inflation target was symmetrical, but given that the annualized inflation rate for the PCEPI from January 2012 to April 2018 is 1.35% it is hard to take this seriously. A reporter asked Powell about the possibility of price level targeting, which as Powell noted, would imply at this time that the US Fed would allow the inflation rate to overshoot 2.0% considerably and for a while to hit a price target consistent with 2.0% inflation. Powell said that the US Fed is not interested in this option now. I would think not, since it seems to be treating 2.0% not as a target rate, but as a de facto upper bound. (The US Fed’s inflation targeting regime has never operated with a de jure lower or upper bound.)
    The US BLS has an experimental HICP for the total population that is almost perfectly comparable in methodology with the UK HICP targeted by the Bank of England. In May its annual inflation rate was 2.61%, up steeply from 2.17% in April. So comparing apples with apples, now the US finally has a higher inflation rate than the UK, for the first time since February 2017.
    Housing prices are still rising rapidly in the US. Zillow Real Estate Research forecast a 6.6% inflation rate for the Case-Shiller national HPI . In February and March the inflation rate was 6.5%. Seattle, Las Vegas and San Francisco had the highest rates of housing inflation in March, all in double digits. Unfortunately neither the PCEPI nor any of the other American consumer price series includes house prices.

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