Leading Economist Mohamed El-Erian: Inflation will ‘stick’ at 4% amid regime change

After raging to many the highest level in four decades In 2022, inflation has fallen steadily over the past six months. But now, a growing number of economists and business leaders worry that the trend won’t last. “I think inflation is going to be tough in the middle of the year at around 4%,” said Mohamed El-Erian, president of Queens’ College at Cambridge University. told Bloomberg on Friday.

Economists have warning about the possibility of persistent inflation since last August, but he is no longer alone. Christian Ulbrich, CEO of JLL, a real estate and investment management firm, Talk to Financial Times This week at the World Economic Forum in Davos, Switzerland, his executive colleagues shared the view that 4% inflation is the new 2% inflation.

Ulbrich believes there are “a lot of fundamental trends” — including decoupling the U.S. and Chinese economies and moving toward green energy — that could even keep inflation “persistent at 5%.” . You might think it’s a small difference, but two to three percentage points is a big deal when it comes to inflation.

Over the past decade, with the exception of a slight bump in 2018, investors and businesses have grown accustomed to the extremely low borrowing costs that have sent home and stock prices skyrocketing. But a world with 4% or 5% annual inflation would force central banks to keep interest rates higher for longer, and that would likely have a spillover effect on equities, freezing. housing market further and forced some corporations to slide into the era of easy money—the so-called “zombieWith a heavy debt load and weak cash flow – bankruptcy. In short, it would be a very different world of finance. Comments by other economists and market watchers suggest a growing consensus that this new world is emerging.

new inflation

In addition to global inflation issues such as the green energy transition, El-Erian explained that there has been a shift in key drivers of U.S. inflation in recent months, which could prevent the Federal Reserve from meeting its 2% inflation target this year.

In 2022, inflation is mainly due to rising commodity, energy and food prices. But now, the economist says, “wage pressure” and price increases in key sectors of the service industry—including medical care and transportation costs—are driving up prices.

“This shift is particularly notable because inflationary pressures are found to be less sensitive to central bank policy action,” he wrote in an article. Bloomberg op-ed Tuesday. “The result could be tougher inflation at around twice the current inflation target level of central banks.”

In 2022, Fed officials raised interest rates seven times to curb inflation. And recently, their efforts have helped slow the steady rise in consumer prices, but El-Erian believes central banks don’t have the tools to effectively combat inflation in parts. of the service sector.

Some sectors of the economy are more vulnerable to rising interest rates than others. Get a home: When the Fed raises rates, mortgage rates go up and that increases the cost of buying a home. It’s an area where central banks can have a very direct, very rapid impact. The service sector is not the same.

When the Fed raises interest rates, things like medical care costs don’t rise immediately like mortgage rates do. That’s part of the reason why overall inflation rose 6.5% year-on-year last month, but service sector inflation when excluding volatile energy costs rose 7% and costs Transportation services — which include things like buses and airline tickets — grew 14.6%, according to the report. Bureau of Labor Statistics.

El-Erian also worries that core inflation, which excludes volatile food and energy prices, could be difficult to tame because businesses are less likely to lower prices once they are raised, even if spending Their fees are falling. In his view, core inflation increased by 0.3% month-on-month in December, while overall inflation fell 0.1%.

Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management, also fears inflation could get stuck at 4%, and she gave three main reasons why on Wednesday article. First, the CIO warned that energy costs could rise over the next six months. Morgan Stanley predicts oil prices will rise more than 20% to $107 a barrel in the third quarter of this year, and falling oil prices have helped push inflation lower in recent months.

Second, Shalett said the weakening strength of the US dollar could cause import prices to rise, exacerbating inflation. And third, a “structural labor shortage” could lead to persistent inflation in parts of the service industry as El-Erian worries, she warned.

“The implication of these risks, coupled with the fact that many investors don’t realize them, is that core inflation is unlikely to fall in a straight line through year-end towards the Fed’s 2% target,” the regulator said. This veteran property writes. “Instead, the decline is more likely to end mid-year, with inflation nearing 4% — a development that could keep interest rates higher for longer and the market could be stuck.” stuck in a tumultuous waiting game.”

Former Treasury Secretary Larry Summers also warned at the World Economic Forum in Davos on Friday that inflation could exceed the Fed’s target.

“Inflation is falling, but just like the transient factors that boosted it before, transient factors have contributed to the decline we see in inflation and as in many journeys, The last leg of the journey is often the most difficult,” he said. told CNBC.

Summers argues that the “biggest tragedy” will be that the world’s central banks stop fighting inflation too soon, arguing that we don’t want to “fight this battle twice.” And El-Erian said on Friday that the Fed should raise rates by 50 basis points in February — instead of 25 basis points as widely expected — to counter current core inflation rather than wait. until “the economy weakens,” arguing that slower rate hikes are more likely to trigger a recession.

George Ball, president of Houston-based investment firm Sanders Morris Harris, thinks we’re in a new, inflation-wise world. “I think you sometimes have a turning point in the economic and investment age,” he said. told Asset last month, “and we are in one of them after more than a decade of near-zero interest rates.”

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