Global underlying price pressures to prompt additional rate hikes

Despite recent drops in headline inflation, underlying price pressures in most developed economies remain high, implying that central banks will need to continue tightening policy in the coming months.

According to the Financial Times, core inflation — which excludes price adjustments for food and energy and is regarded by policymakers as a reliable predictor of price pressure tenacity — is rising rapidly in many parts of the world.

In November, core rates continued to rise in the vast majority of the 33 countries tracked by the FT, and inflation remained well above the two percent target set by most central banks.

Although the proportion of countries experiencing rising core inflation has declined in recent months, it persists far more pervasive than headline inflation. Between October and November, headline rates rose in only one-third of countries.

However, there is still plenty of turmoil ahead, according to Susannah Streeter, senior investment and market analyst at asset manager Hargreaves Lansdown.

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"Stubbornly high prices continue to cause severe headaches for economies,” Streeter said.

"Services inflation will be crucial in determining the path for policy rates,"

Ben May, director of Global Macro Research

Changing strategy to combat inflation

Service inflation, another indicator of price pressure stickiness, in several major economies, including the United Kingdom, the Eurozone, and the United States, has remained near multi-decade highs.

Policymakers have boldly raised interest rates this year in response to a spike in headline inflation measures. However, some have recently started reducing the magnitude of the increase.

As a result of the apparent peak in headline inflation in several countries, the Federal Reserve, European Central Bank (EBC) and Bank of England (BoE) decided to modify their strategy for combating inflation from 0.75 percentage point interest rate increases to a half-point.

According to ECB president Christine Lagarde, the Eurozone’s monetary tightening is still ongoing, and policymakers plan to increase the cost of borrowing in 50 basis point increments in the months ahead.

Lagarde also agreed that underlying price pressures had risen and would continue for some time, a view shared by BoE governor Andrew Bailey and Fed chairman Jay Powell.

Underlying inflation remains high

The initial surge was driven by soaring energy and goods prices as a result of the Ukraine conflict and extreme supply chain meltdowns during the global pandemic.

Increases in prices have become more prevalent, with high inflation reported in areas of the economy that had previously been resistant to price pressures. Since the global economic crisis, wage growth has picked up in most of the world's major economies, most notably in the United States.

With commodity prices stabilizing, headline inflation has dropped significantly in several economies, including the United States, the United Kingdom and the Eurozone. However, underlying inflation measures have yet to join the fray.

Core inflation, the most extensively used measurement of longer-term price pressures, has been and still is at an all-time high of five percent in the Eurozone.

According to Silvia Ardagna, chief European economist at Barclays, ECB policymakers will be concerned if inflation dynamics at the core level do not slow. Despite a two-point drop in headline inflation since the summer, services inflation in the U.S. remains at a 40-year high.

“Services inflation will be crucial in determining the path for policy rates,” said Ben May, director of Global Macro Research. The Fed's policymakers confirmed that core inflation would be stickier than expected last week, raising their forecast for next year to 3.5 percent from 3.1 percent in September.

Regardless of a drop in the headline rate to 10.7 percent from 11.1 percent in October, U.K.'s services inflation is expected to remain elevated in November, staying at its highest level in 20 years. According to the BoE, the persistence of service inflation validates a more aggressive monetary policy response.

Jennifer McKeown, head of global economics service at Capital Economics, said that central banks across “developed markets” have “more work to do.” Streeter also said that while inflation may have peaked, the path ahead is not necessarily a smooth decline.