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    Why central banks may struggle to solve the inflation puzzle

    Why central banks may struggle to solve the inflation puzzle

    May 12, 2023 Global macro
    Over the months ahead, headlines are likely to focus on moderating rates of inflation and growing hopes that central banks can start to ease policy. Although we agree that there is significant downward momentum to inflation in the short term, the medium-term picture is less clear. If central banks cut too early, they risk the medium-term outlook and raise the probability that inflation remains stubbornly sticky above central bank targets.

    Six reasons to be positive on the short-term outlook for inflation:

    1. Food prices are moving lower
    2. The energy price spike is over
    3. Shipping costs have returned to pre-pandemic levels
    4. The COVID-related supply chain bottlenecks have dissipated
    5. China’s reopening could turbo charge the disinflationary pulse
    6. Manufacturing price pressures are easing

    In our view:

    • Service sector inflation is more complicated and tends to be more persistent, so there is good news from energy prices, but tight labour markets suggest wages will remain a problem
    • There is still an open question about inflation persistence, as inflation expectations remain anchored for now, but sticky inflation remains a problem
    • If growth meaningfully weakens, central banks will be faced with a dilemma, as early cuts may prolong inflationary pressures
    • Longer-term inflationary pressures are building, and may make it more difficult to bring inflation back to target on a sustained basis
    • Ultimately, if inflation proves to be structurally sticky and economic activity meaningfully weakens, there is a risk that pressure will grow to raise inflation targets
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