For central banks, higher energy prices are unwelcome news in today’s high inflationary environment. On the one hand, higher energy prices dampen household’s purchasing power and thus economic activity. But higher energy prices feed directly into higher inflation and also higher inflation expectations (particularly in the US). A sustained rise in energy prices could increase the likelihood for stagflation - a true nightmare for any central bank. How does a central bank respond to higher inflation and lower economic activity (higher unemployment)? The experiences from the inflationary era of the 70s would argue for higher rates to stop inflation expectations rising. This is something that the Fed is worried about. As Chairman Powell stated after the latest FOMC meeting: “Energy prices being higher, that is a significant thing. Energy prices being up can affect spending. Over time, a sustained period of higher energy prices can affect consumer expectations about inflation.” Higher energy prices could lead to even higher short-term rates and we see the Fed hiking once more in December. Moreover, higher energy prices will underpin the Fed’s mantra that rates will need to stay higher for longer. - Nordea
Comments