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Recent readings on inflation across countries are baffling. Central bankers who were euphoric with the rebound in economic growth after the COVID-19 pandemic, are now scratching their heads for a solution to tame the inflation beast. The refrain from bankers across countries is “higher for longer” with no defined range for what could be “longer”!

To be sure, the reasons for high inflation are varied. In the US, a roaring economy, strong labour market and vibrant retail consumption are preventing inflation from cooling off to the targeted 2 per cent. In India, while core inflation is rapidly falling, food inflation is elevated, making the targeted 4 per cent inflation an arduous journey. Latest numbers in the UK showed that while inflation did come down, it is not coming down as quickly as expected. Ditto for most countries.

These unending discussions over inflation are grabbing media headlines mainly because of central banks’ decision to stick steadfast to their respective targeted inflation rates, before they start pivoting on rates and start cutting them. The question is: Are higher rates inflationary? This FT piece (free to read for Pro subscribers) has more.

In fact, with every reading of growth and inflation, the expectations on rate cuts are being pushed ahead. Market consensus is pointing to a maximum of two rate cuts in the US this year, from what was four to five at the beginning of 2024. “The great bet on rate cuts — and it was enormous — is dead,” says this FT article.

Explaining further, it says the main reason is we are trapped in old ways of thinking, convinced that inflation will fall back to something that feels like a norm and that central banks will hurry to retreat to the warm waters of low interest rates that dominated the post-crisis era until after war and pestilence arrived. The reality is clearly more complicated than that. Growth is unfettered alongside inflation.

 In India, cutting interest rates may become a bit imprudent if the economy grows 7.1 percent, as projected, alongside volatile inflation, says Rajrishi Singhal referring to it as the silly season conundrum.

Most policymakers also seem to sure that inflationary pressures today are more a function of supply shocks from geopolitical tensions and its impact on trade and foreign policy. Whatever be the reason, the last mile is turning out to be more challenging than envisaged.

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Does this warrant a rethink on inflation rate targets? Keeping rates higher for longer amid elevated inflation can have repercussions of low or negative real returns for investors. High borrowing costs for corporates may take a toll on profitability and can also burden the government itself.

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Technical Picks: Ambuja Cements, L&T, MCX, Wipro and Copper (These are published every trading day before markets open and can be read on the app).

Vatsala Kamat
Moneycontrol Pro