INVESTING EXPLAINED: What you need to know about second-wave inflation

In this series, we debunk the jargon and explain a popular investment term or theme. This is second-wave inflation.

What is this all about?

Chancellor Jeremy Hunt assured us in last month’s Budget that inflation will fall below the Bank of England’s 2 percent target. But pessimistic economists argue that inflation has not been contained in either Britain or the US. And they claim it could spark a comeback – in a second wave.

Why are economists so gloomy?

They point to the experience of the 1970s, which shows that tackling sky-high inflation takes a lot of time.

They also argue that cutting interest rates in the near future – on the grounds that inflation is no longer a threat – would be dangerous for the Bank of England and the US Federal Reserve.

Some of these doomsayers even warn of the possibility of 1970s-style stagflation (sharply rising inflation combined with a slump).

They say the US stock market boom, fueled largely by excitement about artificial intelligence (AI), is the kind of asset price inflation that could reignite broader inflation.

Do they have other concerns?

Yes. They say the spread of conflict in the Middle East raises the possibility of more energy price shocks. The US may be a net energy exporter, but Britain, like the rest of Europe, is more dependent on imported oil and gas.

They also point to rising housing costs in Britain and the US. Higher rents increase the pressure to make generous wage arrangements. In the longer term, population aging means fewer people are working, meaning wage demands will remain high, keeping inflation stubbornly high.

What about a second wave?

The Office for Budget Responsibility (OBR) has looked into the issue. In the document published together with the budget, the Ministry of Finance acknowledges ‘the risks of a spreading conflict in the Middle East, through a scenario in which a sharp increase in energy prices causes inflation to return to an annual peak of almost 6 percent. ‘.

What is inflation in Great Britain?

Total annual inflation was 3.4 percent in February. But the Bank’s governor, Andrew Bailey, has said the base rate for banks – now 5.25 percent – could be cut before the 2 percent target is met. At the Bank’s Monetary Policy Committee (MPC) meeting last month, it was suggested that the base rate could fall in the coming months. The next MPC meeting is on May 9.

And in the US?

American inflation stood at 2.5 percent in February, slightly higher than in January. US Federal Reserve chief Jerome Powell said this week that he was waiting for clearer signs of a slowdown in inflation before cutting rates, but reiterated that it would likely be appropriate to start the process later this year.

What if doomsters are right?

As an investor, it is always wise to take all eventualities into account. Inflation will likely last longer than anyone would like. But it’s also important to remember that today’s circumstances are very different from those of the 1970s.