Inflation Isn’t Dead: Why Central Banks Still Worry in 2023

Inflation Isn’t Dead: Why Central Banks Still Fear Price Pressure

After nearly two years of aggressive monetary tightening, many hoped that inflation was finally under control. Yet, as of September 2023, inflation is proving more resilient and uneven than expected. While headline numbers have declined, core inflation—which excludes volatile food and energy prices—remains stubbornly elevated in many advanced economies.

This ongoing inflation stickiness is forcing central banks like the Federal Reserve, the European Central Bank (ECB), and the Bank of England to keep rates higher for longer, despite rising concerns over slowing growth and potential financial stress. So, what’s driving this persistence in price pressure? And what does it mean for markets, savers, and borrowers heading into 2024?

1. Headline vs. Core: The Inflation Divergence

In many countries, headline inflation has dropped significantly compared to its 2022 peak:

• U.S. CPI peaked at 9.1% in June 2022, and stood at 3.7% in August 2023.

• Eurozone inflation fell from over 10% to 5.2% in the same period.

• UK inflation, though more persistent, also declined from 11.1% to 6.7%.

However, core inflation—which better reflects underlying trends—remains sticky:

• U.S. core CPI: 4.3%

• Eurozone core: 5.3%

• UK core CPI: 6.2%

The implication? Energy price normalization is masking broader inflationary pressure tied to services, wages, and shelter.

2. Why Central Banks Remain Hawkish

a. Labor Markets Are Still Tight

Unemployment remains at multi-decade lows across developed economies:

• U.S.: 3.8%

• Eurozone: 6.4%

• UK: 4.3%

Wage growth has stayed strong—over 5% YoY in the U.S. and UK—particularly in services, where labor shortages persist. This fuels demand-driven inflation that’s hard to quell without raising borrowing costs or slowing hiring.

b. Services Inflation Is Hard to Tame

Goods inflation has eased thanks to supply chain normalization and slowing demand for durable goods. But services inflation—driven by housing, healthcare, and travel—remains high. Unlike goods, services are labor-intensive and less sensitive to global price swings.

c. Inflation Expectations Must Be Anchored

Central banks fear a wage-price spiral if consumers and businesses start to expect persistently high inflation. Long-term inflation expectations have so far remained near target—but that trust is fragile. Policymakers are cautious not to appear complacent.

d. Energy and Geopolitics Remain Wildcards

While energy prices have moderated, oil rose back to $90/barrel in September 2023, partly due to OPEC+ cuts and supply risks tied to geopolitical events. Any energy shock could reaccelerate headline inflation, especially in Europe and Asia.

3. Central Bank Actions as of September 2023

Notably, the ECB’s September hike surprised markets, emphasizing its commitment to bringing inflation back to the 2% target, even as eurozone growth slows.

4. Risks of “Higher for Longer” Strategy

Persistently high interest rates carry macro and financial risks:

• Recession Risk: Rate-sensitive sectors like real estate and manufacturing have already slowed.

• Debt Servicing Costs: Sovereign, corporate, and household borrowers face rising debt burdens.

• Banking Sector Stress: As seen with regional U.S. banks in March 2023, rate shocks can cause duration mismatches and capital pressure.

• Emerging Market Fragility: High U.S. rates attract capital out of EMs, pressuring currencies and external balances.

Central banks are attempting to thread the needle—taming inflation without collapsing growth. So far, soft-landing hopes persist, but risks are rising.

5. Market Reaction and Investment Strategy

Markets in September 2023 have adjusted to the new reality:

• Equities: Volatile. Tech stocks corrected slightly on “higher for longer” guidance, while energy stocks rallied.

• Bonds: Yields remained elevated. The U.S. 10-year Treasury hovered around 4.3%, with flattening curves.

• Currencies: The USD strengthened, especially versus the yen and EM currencies.

• Gold: Held steady near $1,920/oz as inflation hedge narratives clashed with rising real yields.

For investors, the implication is clear: yield is back, but caution is warranted. Fixed income may finally offer returns, but credit risk, duration, and liquidity are key factors. Equities may struggle with valuation compression.

6. Could Inflation Reaccelerate?

Yes. Several upside risks to inflation remain:

• Oil price spikes due to geopolitical escalation or natural disasters

• Supply chain shocks from China (e.g., COVID flareups, port congestion)

• Extreme weather events affecting agriculture (El Niño risks into late 2023)

• Fiscal stimulus persistence in the U.S. and EU green transitions

Even if inflation doesn’t reaccelerate, the path down may be bumpy and slow—keeping central banks vigilant.

7. Global Synchronization Is Breaking Down

Another key trend is the divergence in monetary policy paths:

• The Fed and ECB remain hawkish, although nearing peak rates.

• China, facing deflation, is easing policy.

• Japan is cautiously exploring yield curve control exits.

• Emerging markets like Brazil have started cutting rates after front-loading hikes earlier.

This policy mismatch creates currency volatility, investment rotation, and new macro correlations that investors must adapt to.

8. Structural Inflation Pressures

Some economists argue inflation isn’t just a cyclical event—but part of a structural regime shift:

• Deglobalization: Companies are reshoring or diversifying supply chains, raising input costs.

• Climate transition: Decarbonization pushes up electricity, transport, and construction prices.

• Labor activism: Wage bargaining is intensifying across sectors (e.g., strikes in the U.S. auto industry).

• Demographics: Aging populations in developed economies constrain labor supply and increase public spending.

If true, this means the 2% inflation target may be harder to maintain consistently—and central banks may need new tools.

9. Central Bank Messaging: Walking the Tightrope

In recent speeches, central bankers have emphasized data dependency and cautious confidence. Most have pivoted from outright hawkishness to a wait-and-see tone. Yet, they remain clear: inflation is still the enemy.

Key phrases from recent statements include:

• “Rates will remain restrictive until we are confident inflation is moving toward our goal.”

• “We may be at or near the peak, but not at the pivot.”

• “Core inflation is too high for comfort.”

Expect more volatility around monthly CPI prints, labor reports, and central bank meetings.

10. What Investors Should Watch Next

• Core CPI and PCE data in the U.S.

• Wage growth trends across G7 economies

• Oil and gas futures, especially heading into winter

• Yield curve steepening or inversion shifts

• Corporate earnings, especially in consumer and financial sectors

• Central bank forward guidance at October-November meetings

Conclusion

September 2023 confirms one thing: inflation isn’t dead. It may be quieter, more hidden, and geographically uneven—but it continues to haunt central banks. For markets, this means prolonged monetary tightening, greater policy divergence, and the need to recalibrate asset allocation for a new inflation-normal.

Whether we avoid a hard landing or not, the message from policymakers is clear: victory can’t be declared too soon.