The US consumer price index increased 0.4% for October and 7.7% from a year ago, both lower than estimates.

Fixed income markets have been lifted by the relatively modest US CPI report from last week. But while a cyclical decline in inflation seems very likely, it is the structural factors that will concern central banks the most.

There is some room for optimism that inflationary pressures may be easing in the US although the signs in Europe are not quite so promising. Last week’s US CPI data not only came through below expectations but there were some encouraging signs that underlying price pressures are easing.

For instance, the Cleveland Fed measures of median inflation and the 16% trimmed rate for the CPI eased with the latter, in particular, suggesting that peak price pressure may have passed. As the effects of Fed policy tightening filter through and the economy slows, so a sharp cyclical decline in inflation seems likely.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said the Standard Bank’s forecasts right now suggest a halving in the average annual inflation rate between 2022 and 2023. But the Fed won’t respond to this by easing policy next year. “We continue to expect the Fed to hike 50- bps in December and then lift rates another 50-bps in early 2023 to take the peak to 5% although, just like the probability distribution for the dollar, we don’t doubt that the skew on our rate forecasts lies to the downside”, said Mr. Steve Barrow.

A crucial factor here will be the extent to which the fall in inflation is cyclical and not structural. For while there is – and will continue to be– less price pressure stemming from supply chain problems and labour market tightness, it would be wrong to assume that even a deep recession will remove these headwinds permanently. The pandemic has created cyclical inflationary pressure as demand rebounded and supply could not respond quickly enough. But there will be structural aspects as well. The supply of goods will continue to be impacted over the long haul as countries try to move supply lines to more reliable – but more expensive – sources and many will re-shore supply wherever possible.

On the labour market side, many who retired early during the pandemic, or decided to leave the jobs market for health reasons won’t come back. What this could do is to ensure that the cyclical fall in inflation does not cause inflation to stabilise around the 2% target that the Fed, and most other central banks have for inflation but, instead, at a somewhat higher rate. And that in turn should mean that the world won’t be going back to anything like the zerorate trap that many central banks encountered in the years before the pandemic. This being said, Mr. Steve Barrow still thinks that longer-term yields in the US have now passed their cyclical peak although even if 10-year yields, for instance, were to rise from here we’d not expect an increase much above the 4.25% peak seen recently.

US CPI is easing over the past months

As we mentioned earlier, signs of a price peak in Europe are proving more elusive than the US. This week should see confirmation of a 10.7% annual rate for euro zone inflation in October, while the median forecast for UK inflation in October is also 10.7%. Understandably, there’s not a great deal of talk that the ECB and BoE could start to take things easier on policy as we’re seeing in the US.

In the euro zone, in particular, there’s a significant danger that second-round effects from the surge in energy prices create more structural inflationary pressure in the region. These pressures stem largely from wages which, up to now, have been quite modest. However, this partly reflects the fact that Europe is generally more ised than the US (where wages have risen faster) and hence wage deals tend to be struck over longer periods covering large numbers of workers.

For instance, German employers are in the midst of negotiations with the 3.9m employees in the large IG Metall . The outcome of this deal will not only threaten higher costs and prices but tends to set a baseline for other s to negotiate their own deals. IG Metall is looking for a wage deal of 8%. Typically, the final outcome is much lower; usually around a half of the initial claim. But with inflation soaring, strikes starting and the labour market tight, the final outcome could be higher this time.

“If it is, it will add to the ECB’s woes and increase our confidence that the bank will have to take the policy rate up to 3% next year, which is slightly above the rates currently priced into the market”, said Mr. Steve Barrow.