The unwanted kind of inflation

Our interest rates expert Maarten Spek writes in his latest report that inflation will stay under more upward pressure than central banks had anticipated. This is due to persistent supply side problems and higher energy prices. Central banks have been trying to prop up inflation for years. However, the current bout of inflation is not the kind central banks were hoping for, because it's being caused by insufficient supply, while economic growth is under downward pressure. There is a risk that persistent high inflation (expectations) will boost wage increases and will ultimately trigger a wage-price spiral. In this case, central banks would have to tighten monetary policy considerably. They want to prevent this from happening.

It is therefore quite likely that central banks are pursuing and will keep on pursuing a strategy of loudly hinting at tightening monetary policy, hoping that this will reduce inflation expectations. They could also accomplish their goal indirectly if speculation on tinkering with loose monetary policies triggers a risk-off period, resulting in declining inflation expectations. In this case, central banks will not need to tighten monetary policy at all, or only to a limited extent (by gradually scaling back quantitative easing policies, for example).?

On balance, interest rates on 10-year US government bonds will rise further to 1.8% in the coming weeks or months. If they clearly break through the latter level, they are likely to rise towards the 2% - 2.2% range.

To read Maarten's complete analysis of European and US interest rate markets, please visit our website at www.ecrresearch.com