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WHY IS U.S INFLATION REPEATEDLY DEFYING FORECASTS?

Harvest Global Markets :

The return of unwanted inflation took the world by surprise, but its obstinacy to stick is more startling for the world despite aggressive interest rate hikes. The Federal Reserve’s 2020 forecast of prices advancing by less than 2% for the next two years proved faulty. The Federal Bank was further erred when it anticipated in December 2021 that the general price levels would only rise by 2.6% in 2022, even though the current CPI is lingering around 8.2%. Not only did the Federal Bank misjudge the future inflation numbers several times, but IMF’s estimations also misfired persistently.

A few months ago, Federal Bank targeted the interest rate of the U.S to retrace back to around 0%. Since March 2022, the U.S has experienced a 300 basis point surge in its inter-bank rate, and now the Fed projects its terminal rate of June 2023 to be 4.6%. Analysts blame three factors for inflation continuation- shocks, wages, and expectations.

The outbreak of covid-19 jolted the economies by halting production and creating unemployment. Consequently, economies worldwide, including the U.S, opted for expansionary fiscal policy. Expansionary policies boosted the demand; last year, 40% of the price soar in the U.S was attributed to supply cuts during the lockdown, and 30% of the inflation was a result of demand stimulus packages. Another shock to the world was given by the Russian-Ukraine war, which caused food and fuel prices to escalate. To combat the high inflation, the U.S adopted the path of tightening monetary policy, which peaked the Dollar Index at a two-decade high of 114.71. The appreciated dollar caused imported inflation to boom in other countries. For every 10% increase in the dollar value, it is calculated that the imported inflation in economies rises by 1%.

The second culprit is the wage rate spiral. When prices tend to increase, employees demand higher wages to cover the inflated cost of living. Increased labor cost increases production costs, which are ultimately passed on to consumers in terms of final prices, and the process keeps moving in a loop. Many analysts believe that the U.S economy may be stuck in the labor market cycle.

The third factor, public expectation, is challenging to gauge in monetary terms but plays a vital role in the current economic scenario. Many U.S households believe that inflation will remain elevated in the future. Based on this sentiment, consumers are spending now to save themselves from the climbing prices; the urge to protect themselves from consuming at high prices in the future is putting further demand pressure on prices.

Likely, Fed will not pivot until it witnesses a substantial decline in inflation rates.

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