The last twelve months, inflation has continued to surprise to the upside, due to a combination of a series of supply shocks (covid-19, disruption and shortages, the war in Ukraine, weather conditions) and the strength of demand, which had been underestimated.
Today, the broad-based nature of inflation and its persistence are the real issues, which reduce the visibility in terms of future inflation developments. Therefore, central banks have decided to change their approach. The theory of inflation and monetary policy has been put aside, the only thing that matters are the data.
The main worry of the ECB and the Fed is that inflation expectations become unanchored and influence pricing decision of companies as well as wage negotiations. Consequently, the central banks’ overriding objective is to slow down demand growth by hiking rates, hopefully helped by the absence of new supply shocks.
