Hike rates

Inflation: Will high inflation force the Fed to raise rates next year?

Deepthi Mary Mathew

Economist, Geojit Financial Services

She holds a master’s degree in economics and is currently pursuing her doctoral studies. Prior to joining Geojit, she worked as a senior research associate at the Kochi, Kerala-based think tank for public policy research. Ms. Mathew writes regularly on developments in the areas of monetary policy, fiscal policy, international trade and Union/State budgets.

Globally, the discourse on transitory inflation is slowly fading. At 6.2% in October, the US economy recorded the highest inflation rate in 30 years. Energy and food prices recorded growth rates of 30% and 5.3%, respectively. Core inflation, ie inflation excluding food and fuel, reached 4.5% in the same month. Not just in the United States, other economies, both developed and developing economies, are facing the pain of inflation.

Various factors push the inflation rate upwards. The reopening of economies and the increase in demand are causing bottlenecks for various products. This mismatch between supply and demand pushes prices up.

Developed economies like the United States also face wage inflation. Wage-push inflation occurs when there is an increase in the price of goods caused by an increase in wages. Fiscal stimulus and unemployment benefits provided by the federal government are preventing workers from returning to the labor market. The labor shortage is forcing companies to raise wages to attract workers. The increase in the cost of labor translates into an increase in the price of final goods and services.

The rise in the inflation rate results in a higher bond yield. When US Inflation October 21 was released, the yield on US 3-month Treasury bills rose slightly to 0.43% and the yield on 10-year bonds reached 1.5% (as on November 10 2021). There is a direct correlation between the rise in the inflation rate and bond yields. As the rate of inflation rises, investors demand higher returns to offset inflation risk, reflected in rising bond yields. Higher inflation data along with rising bond yields also pushed equity markets red. Although the consensus is that the Fed would only opt for a rate hike by 2023, if the rise in inflation does not recede, there is a risk of an earlier hike. And, according to the current trend, high inflation prints are also expected in CY22. High inflation as economies recover from one of the most severe crises adds even more pain.

Central banks around the world face this dilemma, as the issues they face are different from last year, when the focus was only on how to revive and help the economic recovery. . Currently, central banks must focus on supporting growth and controlling the rate of inflation. In this scenario, central banks could be expected to accelerate the process of monetary policy normalization, but this would only have a limited impact on the control of the inflation rate caused by the constraints on the side of the offer.