Central bankers have sounded the alarm over the threat of fresh outbreaks of inflation, warning of the effect of deep 鈥渟cars鈥 on households from the post-pandemic price upsurge.
The Bank for International Settlements found that households in 29 advanced and emerging market economies expected inflation over the next 12 months to be about 8 per cent, far higher than the current 2.4 per cent average inflation level.
This raises the threat that price expectations become 鈥渦nmoored鈥 from central banks鈥 official inflation targets, with households and groups responding precipitously to future jumps in prices by demanding higher wages and jacking up prices in a self-reinforcing spiral.
鈥淗ouseholds are very much influenced by the recent inflation experience; when it comes to inflation expectations, it鈥檚 once bitten, twice shy,鈥 said Hyun Song Shin, head of the Monetary and Economic Department at the BIS.
鈥淚t is well-known that surveys of households鈥 inflation expectations tend to overestimate real inflation. But if those perceptions then translate into actions and their behaviour, that鈥檚 going to impact the economy.鈥
Central banks around the world have been trimming interest rates as the worst price surge in a generation subsides. Inflation in advanced economies is set to drop to 2.2 per cent next year, far below the high of more than 7 per cent in 2022, according to IMF forecasts. In emerging economies inflation will drop to 4.6 per cent compared with just under 10 per cent that year.
But officials remain on edge given the lasting legacy of the inflationary upsurge after the end of the Covid-19 restrictions, which was exacerbated in many economies by energy price jumps that followed the Russian full-scale invasion of Ukraine as well as gains in other commodity values.
President Donald Trump鈥檚 trade war has added a new threat, especially in the US, where the Federal Reserve has kept policy on hold this year given the possibility that increases in tariffs to the highest levels in decades drive up consumer prices.
The Basel-based BIS, which advises the world鈥檚 central banks, argued that while temporary jumps in inflation were often viewed as being 鈥渞elatively benign鈥, there was a risk they would lead to persistent increases in inflation fed by upward shifts in expectations.
It found in its annual report that additional forces, such as population ageing, climate change, geopolitical tensions and a less elastic supply side, could all contribute to a more volatile environment, making policymaking more fraught for central bankers.
鈥淗ouseholds, in particular, may show less tolerance for price increases and real wage declines following the sharp rise in living costs after the pandemic,鈥 warned Agust铆n Carstens, general manager of the BIS.
鈥淚f evidence of de-anchoring emerges, central banks must respond quickly and forcefully to inflationary shocks. The uncertainty surrounding the timing, magnitude and future trajectory of tariffs further complicates this task.鈥
Fed chair Jay Powell has highlighted the risk that people鈥檚 memories of post-Covid inflation could complicate the US central bank鈥檚 efforts to stamp out price pressures.
Powell said on Wednesday that US rate-setters had been more sure that tariffs would prove a one-off shock back in Trump鈥檚 first term.
This time around a one-time shock remained 鈥渢he base case鈥, the Fed chair told the Senate banking committee. But he added that given the legacy of the global inflation increase, the threat of a more prolonged bout of tariff-induced price pressures was 鈥渟omething you want to approach carefully in a world where inflation is not back to 2 per cent鈥.
Households鈥 expectations of inflation shot up following Trump鈥檚 unveiling of his 鈥渞eciprocal鈥 tariffs on April 2, with the University of Michigan鈥檚 closely watched polls of short-term and longer-term inflation expectations hitting highs last seen in the early 1990s.
They have since declined following the ratcheting down of trade tensions between the US and China, but they remain at levels that are more than double the Fed鈥檚 2 per cent goal. The Fed has stressed that market-based measures have continued to show that inflation expectations among US investors remain well anchored.
In its latest meeting earlier this month, the Bank of England also flagged risks surrounding 鈥渆levated鈥 household and business inflation expectations, with worries about an oil shock stemming from the Middle East conflict adding to the reasons to be alert.