Inflation has peaked – prepare for a soft landing - by Julian Jessop for the Telegraph - 03.06.22

With UK inflation currently running at 8.3% the implications for investors and consumers could be profound. Higher inflation means higher interest rates leading to a fall in growth and lower returns on investment.

However, in an article for the Telegraph, independent Economist Julian Jessop believes we may have reached peak inflation and that the future directory is sharply down. Why?

In order to predict the future, he says, we need to understand what has just happened:

“There are three parts to this puzzle: the strength of demand, shocks on the supply side, and the role of monetary policy. The third of these is often neglected, but potentially most important.

Central banks under-estimated the resulting demand-pull inflation, partly because they were expecting a much weaker recovery. But they also relied too much on simple ‘output gap’ models that assumed inflation would remain subdued as long as the overall level of economic activity was still far below its pre-Covid trend. This gave too little weight to the dislocation of activity and the heightened pressures in sectors that were still open.

Supply shocks have played an increasing part, as well. Even before the latest invasion of Ukraine, supply chain problems and labour shortages were adding to cost-push inflation. The Russian aggression has exacerbated these pressures, particularly in commodity markets – from energy and metals to agricultural products, including wheat and vegetable oils.

Finally, all of this has been facilitated by a long period of excessively loose monetary policy, with the US Fed, European Central Bank and the Bank of England all continuing to pump huge amounts of money into economies that were already overheating.”

But, says the author, there are reasons for optimism on all three fronts:

“The global economy is slowing and, while this is a ‘bad news’ story in other respects, it will at least ease some of the demand-pull pressures.

More positively, the supply-side pressures may also be fading. Part of the cure here is simply the passage of time. Prices have now been high for many months, providing both the incentive and the opportunity for consumers to find alternative sources, and for producers to increase their output. Higher wages are part of the solution to labour shortages, too.

Indeed, there are already some tentative signs in commodity markets and in business surveys that prices are levelling out, that supply disruptions are starting to ease, and that input cost pressures are peaking. The recent lifting of Covid restrictions in China will also help.

And even if prices simply stabilise at current high levels, the headline rates of inflation will fall sharply as the previous big increases drop out of the annual comparison.

Thirdly, central banks are finally waking up and starting to withdraw some of the exceptional monetary stimulus. The focus here is usually on official interest rates, even though these remain so low that further increases are unlikely to make much difference.”

The more important change is actually the sharp deceleration in the growth of the money supply. This had led some leading monetarists to worry that central banks might be hitting the brakes too hard, but there is still a large overhang from the previous period of rapid monetary expansion.

This has a ‘real world’ counterpart in the build up of household savings during the pandemic, which some at least will be able to use to maintain spending despite a tight squeeze on real incomes.

With a bit of luck, the sharp deceleration in monetary growth should therefore be enough to deliver a soft landing for inflation, without tipping the economy into recession."

The full article can be read here with a link to the original beneath it:

Article for the Telegraph by Julian Jessop - Inflation has peaked – prepare for a soft lan
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