Is Inflation Making a Comeback?
For a while, it seemed like inflation was under control. After hitting a peak of 11% in 2022, inflation across major economies steadily declined. But now, that downward trend is showing signs of reversing. As central banks begin cutting interest rates, inflation is creeping back up. In the U.S., consumer prices rose 3% year-over-year in January, up from a recent low of 2.4%. The U.K. saw an increase from 1.7% to 3%. Even Poland, Germany, and other major economies are experiencing similar upticks.
Lessons from the 1970s
The 1970s taught us a harsh lesson—failing to fully eradicate inflation can lead to disastrous consequences. Back then, inflation dropped from 12% in 1974 to 5% in 1976, only to surge again to 15% in 1980. Central banks didn't act aggressively enough, and when an oil shock hit in 1979, inflation spiraled out of control. It took a deep recession in the early 1980s, led by extremely tight monetary policy, to finally put inflation to rest.
Today’s investors are divided on whether history will repeat itself. Bond markets suggest that concerns about inflation are easing, yet a model from the Federal Reserve Bank of Cleveland indicates that inflation expectations have risen from 2.2% in September to 2.7% today.
Is This a Temporary Blip or a Real Threat?
Some economists argue that the recent inflation spike is misleading. Seasonal adjustments, distorted by the economic upheaval of the COVID-19 pandemic, may be exaggerating inflation readings. Others believe temporary factors—like California wildfires affecting supply chains or trade war fears pushing up food prices—are to blame. Typically, central banks look past short-term price fluctuations when setting policy.
However, not everyone is so optimistic. Inflation measured on a year-over-year basis is undeniably rising. A study by Alternative Macro Signals, which analyzes millions of news articles to detect inflation trends, has shown a sharp increase in inflationary pressure, especially in the U.S.
What’s Driving Inflation Higher?
Tight Labor Markets – The unemployment rate in developed economies has remained below 5% for nearly three years. With companies competing for workers, wages are rising at over 4% annually. However, weak productivity growth means businesses must pass these costs onto consumers.
Rising Service Prices – Inflation isn’t just about goods; it’s hitting services too. In major economies, service prices are increasing by 4% annually, double the pre-pandemic rate. In Portugal and Estonia, service inflation has jumped significantly in recent months.
Political Decisions – Governments may inadvertently fuel inflation. In the U.S., Donald Trump’s proposed mass deportations and tariff increases could drive up labor and import costs. Other countries, in turn, may retaliate with their own tariffs. Additionally, many governments are boosting spending, such as the U.K.'s infrastructure push and Italy’s tax cuts, which add more fuel to inflationary pressures.
Inflation Expectations Matter
Once inflation takes hold in people’s minds, it becomes even harder to control. Workers and businesses anticipating price hikes act accordingly—demanding higher wages and adjusting prices upward. Google searches for “inflation” remain twice as high as pre-2021 levels. In the EU, despite inflation falling below 3%, consumers still expect prices to rise by 10% over the next year. In Canada, where inflation is currently at 2%, people still anticipate a 3% increase.
What’s Next?
Not long ago, central banks were celebrating their success in bringing inflation down. But just like homeowners dealing with cockroach infestations, a premature sigh of relief can be costly. If inflation expectations continue to rise and policymakers miscalculate, we could be in for another prolonged battle.
Investors should brace for potential volatility, monitor central bank moves closely, and consider how inflation-resistant assets fit into their portfolios. After all, inflation may not be gone—it may just be getting started again.