As inflation rears its head, central banks strike a precarious balance

WHO'S afraid of inflation? The US Labour Department's announcement that US headline inflation advanced by 6.8 per cent in November has rippled through financial markets.

It is the highest rate since June 1982 and comes in the wake of several months of inflation above the Federal Reserve's 2 per cent target. When Fed chairman Jerome Powell described inflation in April as "transitory'', there appeared to be good reasons for this. Pandemic lockdowns in 2020 suppressed economic activity and travel across the board, creating an essentially deflationary environment. This year tells a different story, however. Economies have re-opened following a global roll-out of vaccines. The subsequent explosion of demand has caused supply chain bottlenecks. Coupled with wage pressures, these factors have pushed up inflation rates which are also rising off a low 2020 base.

The big question is - how entrenched might inflation become? In his testimony before Congress in December, Powell has dropped the "transitory'' descriptor and pivoted towards a more rapid withdrawal of pandemic support. The Federal Reserve aims to taper down bond purchases from January, and is now widely expected to mount 3 quarter-point interest rate hikes in 2022, and 2 to 3 more in 2023. These are expected to take the policy rate to 2.1 per cent by 2024. The Fed also dialled down its GDP projections for this year to 5.5 per cent in 2021, from 5.9 per cent. In their new economic projections, policymakers forecast an inflation rate of 2.6 per cent next year, before falling to 2.3 per cent in 2023.