As we expected, US inflation numbers have continued their climb, beating many market forecasts by rising 5.4% in the year to June. Core inflation rose 4.5%. The monthly jump was 0.9%.
Whilst used cars continued to be a substantial part of the rise – accounting for around one third of the increase – this should now start to tail off. There was strong pricing from hospitality, clothing and travel as well.
This current inflation is not just a few supply chain difficulties in semiconductors and some commodities. It is also generating wage pressures as people are proving reluctant to take lower-paid jobs in the parts of the economy that are reopening. The inflation may be higher and longer than the Fed thought, and will doubtless force them to make policy changes, starting with a phase out of mortgage securities and bond-buying. The Fed assumes because there are people who could take a job there is plenty of spare capacity to keep costs down, but that needs more people to want to take the jobs on offer.
UK inflation has also surprised some on the upside, with CPI rising 2.5%. The official preferred measure of the CPI including housing rose 2.4%. This is altogether more muted than the US, reflecting the much lower level of monetary and fiscal stimulus on this side of the Atlantic compared with the US policy of running hot. It may well go higher over the balance of this year, but the Bank of England has already proposed action to bring inflation back down again next.
Climate change front and centre
Meanwhile, central bankers are looking elsewhere. Randal Quarles, the Chairman of the Fed’s Financial Stability Board has given a speech about climate-change policy. He has set out the need for global coordinated policies to tackle climate change through the G20 and its Sustainable Finance Working Group. He has called for international agreement on approved global disclosure requirements for companies and banks, and more reliable and agreed data to see how they are doing. He wants more attention paid to the risks that climate change may pose for individual companies and looks to the International Sustainable Standards Board to help with monitoring the situation.
This statement mirrors the work of the European Central Bank (ECB), which has also stepped into the debate about how the financial markets and institutions should contribute to the green transition. The ECB has promised to “further incorporate climate change considerations into its policy framework.” It argues that “climate change and the carbon transition affect the value and risk profile of the assets held on the Eurosystem’s balance sheet”.
The ECB is undertaking work to incorporate climate factors into its models to compile data on carbon footprints, and to include green issues in the assessment of collateral and bond purchases. It will be running climate change stress tests and talking to credit rating agencies about including green risks in the assessment. A well-financed fossil-fuel company could be downgraded for its general business risk from the transition to renewable energy.
The winners are green
All of this points to a world where the central banks will be nudging investors to value the agents of green transition more highly – and to downgrade the areas they wish to cut or abolish. Central banks do have some influence directly by their decisions on which bonds to buy and which lending programmes to back and more indirectly by influencing the conduct of the commercial banks who need support and co-operation from the central bank.
Meanwhile, the ECB has a split over how far it should continue with bond-buying and money creation. A group of countries led by Germany worry that they are heading to a world where the states that lack discipline over spending and borrowing can get a free ride through the ECB underpinning state borrowing at very low rates.
The Fed sets out in public a few of its worries about how high and for how long inflation may go in America. The Fed persists in using the personal consumption expenditures index which was running at 3.9% a year growth in May, rather than the CPI which hit 5% that month. The official narrative states that inflation will run high for up to a year thanks to temporary shortages and re-opening pressures, but will then settle back down to around 2.25%. The Fed wishes to run it at that rate for a period to get the average up to closer to 2% following recent years of undershooting.
Life rarely works out as perfectly as the current Fed forecasts. It wants to run the economy hot without setting fire to inflation. They may find they need to dampen their boiler soon if they are to avoid more enduring and self-sustaining inflation as temporary price rises in some goods and commodities start to transmute into higher wages and rising prices for services.
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