Inflation momentum in the US may, at last, be decelerating, but the threat is far from over, says a report from the Swiss Re Institute.
Despite 225 basis points of interest rate hikes this year, some measures of US financial conditions are at the loosest since the Federal Reserve System (Fed) started to raise rates in March.
The institute views such financial conditions are inconsistent with the existing and considerable inflation pressures in the US economy.
The report suggests the Fed needs to stay its course on tightening and not succumb to markets’ implied pricing of rate cuts in 2023. Financial conditions will need to tighten and stay tight, for inflation to be addressed in a sustainable manner.
In July, US headline and core inflation came in at 8.5% and 5.7% year-over-year. Both measures did not increase much on a month-on-month basis, and other indicators also suggest that inflation momentum is starting to slow, albeit from a very high level.
Yet, many measures of underlying inflation, such as unit labour costs, shelter-related expenses and trimmed and median inflation, still indicate way too much momentum for comfort, suggests the report.
Since financial conditions started easing again in July, the price of a broad commodity basket has increased by about 10% while longer-term inflation expectations have also perked up.
The institute states that the easing financial conditions in the current environment become self-defeating as they reinforce, instead of hinder, inflation pressure.
Keeping financial conditions where they are now could exacerbate and prolong inflation risks, says the report, unless financial conditions tighten by themselves, the Fed will have to be more aggressive than currently priced should core inflation pressures prove more permanent.
