Brace Yourself: Higher Inflation and Interest Rates Could Be the New Normal

Investors and homeowners need to prepare for the possibility of high inflation and interest rates in the coming years. Recent readings from the US and Europe suggest that global inflation may not be subsiding as quickly as markets had hoped at the beginning of the year, despite positive news on supply chains and energy prices. For example, the Federal Reserve’s preferred measure of core inflation rose in January in the US, while core inflation in the Eurozone hit a record high in February. These indications suggest that higher inflation might become a permanent feature in economies due to soaring corporate profits during the pandemic and drum-tight labor markets that place workers in an excellent position to demand higher wages.

Inflation and the Risk of a “No-Win Situation” for Central Bankers

Doubts are emerging about how far inflation can fall, especially without a significant recession. For example, a Harvard economist revealed that current wage growth in the US is consistent with 4% inflation, while the pattern in Canada is similar. With low unemployment levels in both countries, wages will probably continue growing rapidly. But this means that inflation and interest rates will remain elevated, with the risk that 4% inflation could become the new norm over the next few years.

This creates a “no-win situation” for central bankers. Double the Bank of Canada and Federal Reserve’s preferred rate, 4% inflation, although not outrageous by historical standards, could lead them to proceed with a light touch. On the other hand, however, they may decide to keep interest rates at elevated but not brutal levels, hoping that inflation gently declines over the coming years. Nonetheless, this choice carries some significant risks.

Risks for Central Bankers

One risk is that a new emergency could send inflation soaring from its already elevated level and turn a moderate headwind into a full-fledged inflationary hurricane. Again, the 1970s were the prime example, as inflation soared to double-digit levels following the 1973 oil crisis and then rose to even more mountainous highs by the decade’s end.

The second risk is that making peace temporarily with higher inflation may lead to a significant loss of credibility for central bankers, which could trigger an exodus of investments and result in much higher borrowing costs.

Related Facts

• The US inflation rate increased from 1.4% in January 2021 to 5.4% in June 2021.
• Inflation in Canada reached a peak of 3.7% in May 2021.
• Additionally, unemployment rates in both countries are at multidecade lows.

Final Thoughts

In conclusion, regardless of whether central bankers choose a “light touch” or attempt to control inflation through other measures, investors and homeowners must prepare for the likelihood of high inflation and interest rates in the coming years. The current upward trend is not just temporary but could become a permanent fixture in the economic landscape. Therefore, a cautious and prudent approach to investments and financial planning is necessary to mitigate the potential negative impacts of higher inflation and interest rates.

Key Takeaway

Investors and homeowners should brace themselves for high inflation and interest rates becoming a permanent economic phenomenon. Accordingly, they should take a cautious and prudent approach to investments and financial planning to mitigate potential harm.