Central bankers see ‘immaculate disinflation’ within reach

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Central bankers are increasingly confident that inflation can be vanquished without driving up unemployment sharply, as economists forecast “immaculate disinflation”.

Analysts polled by Consensus Economics see inflation easing from multi-decade highs to about 2 per cent this year in most advanced economies including the US, Germany, France, UK, Italy and eurozone.

Victories over inflation have traditionally come at a heavy cost, as harsh monetary policy measures lead economies into recession and push up jobless rates. UK and US unemployment rates doubled in the 1980s as borrowing costs rose to tackle high inflation triggered by oil price shocks.

But this inflationary cycle is seen as taking a different course. Michael Saunders, economist at Oxford Economics, noted that inflation was forecast to return to target with only a limited increase in unemployment in the US and eurozone.

“Immaculate disinflation, whereby inflation returns sustainably to target without a significant rise in unemployment, has become the base case,” he said.

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Inflation has already more than halved across the Atlantic over the past two years. Eurozone price growth was 2.6 per cent in February, down from an all-time peak of 10.6 per cent in 2022. Inflation has fallen from a high of 11.1 per cent in the UK to 4 per cent, and from 9.1 per cent to 3.2 per cent in the US.

However, unemployment is at a record low in the eurozone and is forecast to average 4 per cent this year in the US — not far from the 50-year low of 3.6 per cent in 2023, according to the latest monthly survey of economists from Consensus Economics. The UK’s joblessness rate is set to rise only to 4.4 per cent in 2024 and 4.5 per cent in 2025 from its near 52-year low of 3.9 per cent.

This pattern of “disinflation at full employment is unusual . . . in our modern history” and “quite striking”, Bank of England governor Andrew Bailey said last week. “The UK, I think, is not alone in experiencing disinflation while preserving full employment.”

Adriana Kugler, a member of the Federal Reserve Board, said this month: “While interest rates rose rapidly, some feared that the cost of disinflation would be persistently elevated unemployment. But over the past year or so . . . we have seen inflation cool significantly, falling more rapidly than at any time since the 1980s. Yet unemployment remains near the lowest levels seen only a few times since the 1960s.”

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Many economists, including Bailey and Kugler, have attributed the phenomenon to the nature of the latest inflation surge, which was linked to global supply shocks such as Russia’s full-scale invasion of Ukraine and pandemic disruptions.

“The 2021-2023 inflation surge across advanced economies was different because it mainly reflected adverse supply shocks, rather than strong aggregate demand,” said Saunders.

Jennifer McKeown, chief global economist at Capital Economics, said high wage growth, which policymakers monitor closely as a key driver of domestic price pressures, resulted from higher inflation expectations linked to elevated energy prices and pandemic-related worker shortages in some sectors.

She said such wage growth was starting to come back down, even without a sharp rise in unemployment, because price growth and inflation expectations had normalised while Covid-19 distortions had evened out.

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The speed of the central banks’ response was also a factor in preventing higher inflation from becoming stickier, economists said.

“The reason that the supply shocks of the ’70s-’80s became entrenched was central banks didn’t understand the role of inflation expectations and the cost of living adjustments in many labour contracts,” said Mark Zandi, chief economist at Moody’s Analytics.

He added that immaculate disinflation wrongly suggested that the trend was unexplainable, when “disinflation is primarily due to the fading economic fallout from the pandemic and Russian war in Ukraine”. That, he said, “was predictable”.

With the impact of the shocks rapidly fading, delivery times are now back to pre-pandemic levels and shipping costs are only a fraction of what they were in 2021. European wholesale gas prices and global agricultural commodities prices are roughly back to their early 2021 levels, before their war-related rises.

All these factors are helping inflation come down earlier than central banks expected only last year. They are also pushing inflation expectations down, which reduces the risk of sticky price pressures feeding into wage negotiations.

“I am cautiously optimistic that we will see continued progress on disinflation without significant deterioration of the labour market,” said Kugler.


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