Is inflation out of control?

Inflation, inflation, inflation – it’s the economic indicator on every corner of the market’s mind. Is it transitory? If so, for how long? Will it be permanent? Are we on the brink of hyperinflation? Central banks were at odds as to why inflation was muted in the 2010s despite the vast amounts of central bank liquidity since the GFC. Oh, how times have changed.

The fact of the matter is inflation is here and it’s causing central banks all over the world great concern as the factors driving the rapid surge in prices are largely outside of their control. However, there are 2 elements central banks can influence in the current cycle: Demand and inflation expectations.

Elevated levels of consumption of goods have contributed in part to supply chain disruptions as consumers are demanding more than they did before the pandemic and during 2020. At first, the demand helped spur on the global recovery in growth, but it is now creating a bottleneck in supply chains as once globally connected manufacturers and suppliers asynchronously open up, navigate new structural hurdles and fight for raw materials.

The larger cause of concern for central banks like the BoE is that inflation expectations become embedded. The theory goes that if consumers and businesses become more accustomed to expecting prices to increase rapidly, it makes it easier for businesses to pass costs on to the consumers and for consumers to demand wage increases. Essentially, it’s a self-fulfilling prophecy as expectations become reality and the cycle perpetuates. The hawks on the Bank of England’s MPC have been talking up the prospects of a rate hike before the end of the year to combat this idea and the market has reacted aggressively. The chart below shows how the Sterling Overnight Interest Swap (OIS) curve has become considerably steeper from before the BoE meeting on the 23rd September to now.