Will inflation be painful?

US inflation last year, as measured by the CPI, rose 7% between December 2020 and December 2021. 

US inflation last year, as measured by the CPI, rose 7% between December 2020 and December 2021. That’s a story in itself, as is the surge in inflation in most other countries. The extent of the rise was totally underestimated, even if the direction of travel (upwards) was pretty clear. Consumers lose out from unexpected inflation, in part because they do not bargain for higher wages in anticipation of sharply increased prices. But they also lose out because prices have gone up on most items that people have to buy.

Last year, gasoline prices in the US rose almost 50%, and natural gas prices were up nearly 30%. Of course, some actions can be taken to avoid depleting income, such as taking fewer car journeys, but there is only so much that can be done here. Rental prices also surged; up some 17% (a record) according to Apartment List, and not the far more miserly sub-5% rates that were recorded in the shelter component of the CPI.

"In other words, official data probably underrepresents the rise in the cost of living that consumers had to endure last year. Of course, things could ease in 2022 but that seems unlikely. If we switch to the UK, for instance, where CPI inflation scaled 5% last year, there’s a much-anticipated surge in the cost of gas prices for consumers coming in April as energy suppliers see the restriction, or cap, on how much they can charge customers lifted by the government. The rise here won’t be modest with a figure of around 50% seemingly most likely; a figure that could help push annual inflation to over 7% by the spring. In contrast, if we look at the prices of goods that consumers can choose to buy the numbers are not so scary. The most obvious one of these is airline flights given Covid. The annual increase in the US last year was just 1.4%. Clearly some people do have to fly and will have benefitted from the low level of inflation here but, for the vast majority there’s been little benefit at all. The same goes for many other categories of the CPI, like personal care services", Mr. Steve Barrow, Head of Standard Bank G10 Strategy said.

Does any of this have a bearing on how central banks might look to tackle inflation this year? It could, for example, make them more reticent to hike rates significantly for two reasons. The first is that energy prices are volatile and high prices in areas like oil and gas might not stick and could even reverse swiftly. Another is that high inflation in these have-to-buy areas is likely to eat into family finances particularly hard and so cause the sort of tempering of expenditure that obviates the need to resort to sharp rate hikes. While it is possible that central banks could respond in this way, we think it more likely describes how they approached the situation 6 months ago, not now. For now, it has become clearer that, while the really extreme price increases are largely related to these need-to-buy sectors, there is greater underlying pressure elsewhere.

Another point is that, while consumers will feel the pain of the rise in inflation, they do, at least have a savings cushion from the pandemic. This exists because people are unable or unwilling to make discretionary expenditures in many areas, like holidays, or because people receive direct government help, particularly in the US.

Mr. Steve Barrow doubted that policymakers would go too easy with rate hikes just because they believe that surging inflation in necessities like gas will produce a sufficient crimping of expenditure and hence inflationary pressure. However, what he might find is that more of the monetary-tightening legwork is done via balance sheet policies (quantitative tightening) than currently anticipated. If so, this might mean that slightly more of the tightening burden is felt at the longer end of the curve meaning that curves don’t necessarily invert as the rate hikes come through.