Lagarde highlights tit-for-tat inflation dynamic

Two weeks ago, European Central Bank chief economist Philip Lane alluded to an unforeseen dynamic in this inflation crisis. Some of the surprise stickiness in inflation was coming from goods inflation.

This should have come down with the reopening of supply chains but has remained stubbornly elevated, a trend he associated with increased corporate profits.

Yesterday his boss Christine Lagarde also raised the notion of companies profiteering on the back of inflation, warning that a “tit-for-tat” dynamic between companies and workers was threatening to keep price growth higher for longer.

“So far, we do not see clear evidence that underlying inflation is trending downwards,” she said. However, Lagarde noted there were two forces pushing underlying inflation in different directions.

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Lower energy prices are pushing inflation down but stronger-than-expected domestic demand is offsetting this, as firms increase profit margins and workers push for higher wages in tight labour markets.

She wasn’t exactly warning of a wage-price spiral but gently alluding to one. Policymakers in Europe and the United States are confident inflation is coming down but the headline barometers have yet to reflect this confidence.

Last month Irish inflation unexpectedly ticked up while UK inflation was yesterday reported at 10.4 per cent in February, up from 10.1 per cent in January, pushed up by higher food and drink prices in pubs and restaurants, placing renewed pressure on the Bank of England to increase rates again. The UK’s Office for National Statistics blamed the rise on supermarket shortages last month, which drove up the prices of vegetables and salads.

Paul Dales, chief economist at Capital Economics, said: “The reacceleration in overall CPI [consumer price index] inflation and core inflation may be enough to tilt the Bank of England towards raising interest rates from 4 per cent to 4.25 per cent tomorrow despite the recent turmoil in the banking system.”

There’s obviously a lag between lower energy prices and lower inflation that has yet to play out. Sceptics think the second round effects of higher energy prices will prove more stubborn to shift, policymakers are more optimistic.