'The truth is no one knows if inflation will come down'

The move, which came on the heels of a better-than-expected inflation figure earlier in the week, begs the question: is inflation finally coming down?

The shockingly simple answer is: no one knows.

Across the City, professional forecasters disagree and change their minds almost on a weekly basis. According to a survey by Bloomberg, inflation for 2024 will be anywhere from 2 per cent to 4.5 per cent – an extremely wide range of outcomes. And they still might miss the mark.

The market has been persistently wrong about both price rises and the course of interest rates for more than 18 months.

In September 2022, the bond market was pricing in a terminal (highest) rate of 3.5 per cent. Two months later, the number was 4.6 per cent. We are now nearly 1 per cent higher than that, and we could end up even higher.

While encouraging, we must not read too much into the BoE’s decision to skip a hike.

The experience from the 1970s is that inflation is a rather tricky and dangerous animal that should never be underestimated. Much like a wild bear, the longer it hibernates, the smaller the experience policymakers have in dealing with it and the more ferocious its appetite becomes.

But, unlike the bear, it will not go back to sleep at a predicted time. In fact, it can take years to put back in its cage.

After a wild ride in the 1970s and 1980s, inflation went missing for more than two decades since China ascended to the world stage in the mid-1990s and began to export deflation (in the form of cheaper TVs, toys, parts, etc).

Economists were wondering whether we would see prices rising again, or whether high levels of debt had 'Japanised' the global economy beyond repair.

How did we get here?

It took the combination of big and unpredictable events to change that status quo and wake up the sleeping beast. It started with the pandemic and lockdown, which threw global supply chains into disarray.

Then, the pandemic accelerated China’s metamorphosis from a global producer to a global consumer nation and a competitor for geopolitical supremacy, which meant that Chinese disinflation would no longer provide comfort for Western consumers.

Even then, inflation was viewed as transitory by central banks who predicted it would go back to sleep soon. It may well have gone that way, were it not for a third catalyst, the war in Ukraine, which caused massive rises in food and energy prices.

Meanwhile, consumers, especially in the US, found themselves with a lot of extra cash due to pandemic support cheques and savings.

As the world transitions from Chinese to India-based supply chains and at the same time invests massive resources towards energy sustainability, yet more inflation is generated.

Our generation has not really had much experience with either inflation or wage growth. In the 1990s, salary negotiations used to be an annual brawl every manager dreaded. A decade and a half of zero interest rates and sub-par growth rendered those meetings a mundane affair.

However, labour shortages, a result of vast changes in the skills market and, yes, Brexit, as well as persistent post-pandemic inflation have led workers to work up the courage and ask for more money.

By July 2023, the annual rise in UK wages was a staggering 7.8 per cent – the biggest increase in more than 20 years.

Additionally, the tight housing market generates yet more inflation. While house prices are down, rents remain very high. UK rental prices are up 5.9 per cent since last year – the highest since the survey began in 2006.

Thus, the forces that prompt higher inflation are mostly there:

• geopolitical disturbances and tectonic shifts;
• labour market dynamics;
• housing pressures; and 
• consumer savings.

So why did the BoE stop hiking rates?

While encouraging, we must not read too much into the BoE’s decision to skip a hike. The UK central bank may have paused for one session, but they have not indicated that interest rates have peaked.

The central banker's line of thinking today is that, if interest rates remain at a high level for some time, they will continue to squeeze demand.

Recent data suggests that companies are now losing pricing power. This means that they will have to eventually say no to further wage hikes, in order to protect their margins and the inflation cycle will start to unravel.

But the truth of the matter is that, even then, we still do not know how and when inflation will recede.

At the time of writing, Saudi Arabia and Russia, emboldened by the production limitations of US shale oil producers, are testing the tenacity of oil prices around the $90 (£74) level – 35 per cent higher than in June.

This could start a whole new cycle of supply-side inflation, which would then turn into demand-side inflation.

In the words of writer Kurt Vonnegut Jr, “so it goes”. 

George Lagarias is chief economist at Mazars Wealth Management