The fight against inflation in the U.S. and Europe is proving to be a challenging battle, with recent trends showing a halt in the decline or even slight increases.

This shift is challenging the assumptions that guided central bank policies and market expectations.

After witnessing a decline from the highs of approximately 9% to 10% across advanced economies in 2022, which were largely attributed to easing supply-chain blockages and normalisation of commodity prices, the journey towards lower inflation has hit a roadblock.

Underlying inflation, which excludes volatile food and energy prices, had slowed to 3% in the latter half of last year but has since inched up to 3.5%, according to estimates by JP Morgan.

This trend is causing investors to reconsider their expectations that inflation would steadily decline towards central banks’ targets, typically around 2%.

U.S. Federal Reserve

Commodity markets

There are growing concerns that inflation could surge once again, echoing the second wave that characterised the high inflation of the 1970s.

Economists and central banks had been forecasting sustained decreases in inflation, contingent upon strong factors such as global labor costs, short-term expectations, and signals from commodity markets.

However, recent data suggests that these factors might not be aligning as anticipated. Services inflation remains elevated, and goods prices, which had previously fallen, are now on the rise.

Central bankers had anticipated that the final stretch of reducing inflation would be turbulent. However, they are indicating a readiness to wait before resorting to rate cuts.

A deviation from expected rate cuts could have significant repercussions for the global economy and markets, which had rallied on the assumption of such cuts.

Recent data from the U.S. Commerce Department revealed that the price index of personal-consumption expenditures, the Federal Reserve’s preferred inflation indicator, rose by a modest 2.5% in the 12 months through February.

However, the index excluding food and energy witnessed a more significant increase, climbing by 3.5% on an annualised basis over the three months through February.

Slowing progress

Fed governor Christopher Waller expressed concerns about the slowing progress on inflation, suggesting a need to reconsider the frequency and timing of rate cuts.

Fed Chair Jerome Powell, however, maintained a more balanced stance, highlighting the occasionally bumpy path toward 2% inflation and said the strength of economic growth as a factor allowing policymakers to wait for more data.

Joachim Nagel, president of Germany’s Bundesbank, cautioned against premature rate cuts, citing the risk of missing inflation targets and the potential need for subsequent rate hikes.

He referenced an International Monetary Fund report that highlighted the persistence of inflation shocks over extended periods.

Stubborn inflation

Eurozone countries are also grappling with stubborn inflation.

In Italy, underlying inflation edged higher in March, while French services prices remained elevated despite a cooling headline inflation rate.

The resilience of economic growth, particularly in the U.S., coupled with strong consumer spending and job creation, has contributed to the persistence of inflationary pressures.

While Europe’s growth has stalled, recent indicators suggest a potential upturn. Additionally, wage growth remains high, reflecting tight labor markets, and is a significant driver of services-price inflation in the eurozone.

Central banks may inadvertently be contributing to inflationary pressures by signaling a pivot toward rate cuts, which has suppressed borrowing costs and boosted asset prices.