Inflationary pressures continue to build on both sides of the Atlantic. In the US the annual rate of inflation jumped again in March to 8.5% from 7.9% in February. In the UK inflation hit 7%, up from 6.2% in February.

This has placed mounting pressure on central banks that have been tasked with controlling inflation.

However they are ill-equipped to do so given that interest rate increases (the principal weapon in the central banks’ toolkit) only influence demand when supply constraints have been the principal cause of inflation.

The twin forces of technological innovation and globalisation, rather than the policies pursued by central banks, have been responsible for the structural decline in both interest rates and inflation in recent decades.

The unwinding of these forces has exposed the central banks. 

Moving forward China’s zero-Covid approach is likely to further exacerbate both supply chain disruptions and inflationary forces.

In a recent tweet Michael Burry (the infamous investor who played a key part in the book and film charting the financial crisis, The Big Short) claimed the Fed has no intention of fighting inflation:

‘The Fed’s all about reloading the monetary bazooka, so it can ride to the rescue and finance the fiscal put,’ he said.

In other words Burry believes the Fed will always intervene to prevent markets from falling too far and needs to put up rates in the short term to give it the capacity to fulfil this role.

RESHORING FUELS INFLATION

In the last two decades the proliferation of globally integrated supply chains has facilitated an increase in imports from low wage economies like China.

These have made it easier to shift different parts of the production process to where it can be produced most cheaply, thus reducing inflation.

And in the UK, the free movement of labour before Brexit helped keep a lid on labour costs.

Developments in technology including the emergence of price comparison websites have also played a role in reducing inflation, by simultaneously increasing price transparency and restraining large retailers’ margins.

Brexit, and more recently Covid, have highlighted the importance of having access to local supply chains. As a result many of the previous benefits of globalisation are starting to unwind, contributing to higher inflation.

Central banks don’t have the tools to deal with supply-side shocks and the conflict in Ukraine has only added to supply constraints for food and fuel.

On 7 March international oil benchmark Brent Crude hit nearly $140 per barrel after the US and Europe took steps to block Russian imports.

Russia is the world’s second largest producer of crude oil and has historically supplied approximately a third of Europe’s needs.

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