What happens to rates, inflation and jobs in America
Labor markets are loosening due to increased supply. People are re-entering the workforce and immigration is picking up again. Analysis by Steven Bell, Chief Economist EMEA of Columbia Threadneedle Investments
Central banks say they expect interest rates to remain high for an extended period, while I personally expect strong rate cuts in 2024. Central banks' hawkish tone has remained even as they admitted that official rates are now close to their peak. In fact, both the Federal Reserve and the Bank of England kept rates steady in their latest meetings. Why can we be more optimistic about the outlook for interest rates than central banks or market prices?
THE CENTRAL BANKS' ASSESSMENT ERROR
In the background we have central banks who, collectively, were unable to prevent the surge in inflation that followed the end of the Covid pandemic and the invasion of Ukraine. Some might say that they were slow to appreciate the extent of inflationary pressures, seeing them as transitory. Now, however, it is important that central banks realize the power of the disinflationary forces underway and act accordingly.
RAW MATERIALS PRICES
Among these forces, commodity prices are undoubtedly the most noticeable. The Bloomberg commodity price index has fallen 24% from its peak last June, after doubling from its spring 2020 lows.
This is a huge turnaround. Despite recent oil price increases, the index is still declining overall. Furthermore, although central banks focus on core inflation, which excludes food and energy prices, commodities have indirect effects on factors such as transportation and restaurant prices. Given the scale of the turnaround, this is important.
Furthermore, wage negotiations tend to depend more on global inflation than underlying inflation, and the wage price spiral is now working in reverse, particularly in the United States.
THE LABOR MARKET
The second factor is the job market. With the end of pandemic restrictions, a severe labor shortage has developed across developed countries. This has led to a surge in nominal wage inflation. However, an exceptional adaptation to this shortcoming has occurred.
Employment is still rising in the UK, US and much of Europe, but the pace is slowing, while job supply is increasing as the after-effects of the pandemic ease: people are returning in the workforce and immigration is picking up again.
In the UK, labor supply is increasing by 1-1.5% per year, driven by non-UK-born workers. The increase is even faster in the United States. These numbers may seem small, but they are large enough to lead to a significant increase in unemployment that should be evident by the end of the year.
PEOPLE HAVE CONFIDENCE IN THE DROP IN INFLATION
All of this is happening in a favorable environment, where people still have faith that central banks will be able to bring inflation back towards target, despite current levels. Inflation expectations are still well anchored, which will make the disinflationary process faster and less painful.
WHAT THE CENTRAL BANKS WILL DO
Personally, I believe that the Federal Reserve will start cutting interest rates in early 2024, that the Bank of England will follow shortly thereafter and that the ECB will join a little later, although the precise timing will depend from the data. We should see cuts approaching 2% in the UK and US, while ECB rates will fall a little less in 2024.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/inflazione-lavoro-cosa-succede/ on Sun, 08 Oct 2023 05:45:06 +0000.