For a long time now, many analysts have argued that long-term structural factors will keep inflation elevated across the G10, such that the era of significant disinflation, even deflation, between the global financial crisis and Covid will not return. Instead, central banks will most often have to fight inflation that is above target, not below target. That was clearly evident with the post-Covid surge in inflation to double-digit levels for many major G10 nations, but even in the period when inflation has come back down, it has not settled at sub-target levels.

In the US, for instance, inflation has seemingly settled at levels closer to 3% than 2%. This is viewed as the ‘new norm.’ Indeed, the fact that the likes of the Fed and the Bank of England are still cutting rates when inflation is above target suggests that there may be some acceptance of this fact amongst policymakers even though they would never admit it. The structural factors that seem likely to keep inflation more elevated include global trends of deglobalization, climate change, and shifts in demographics.

Steven Barrow, Head of Standard Bank G10 Strategy does not believe that these factors suggest that double-digit inflation will quickly return to the likes of the US and the UK. The experience of these countries, and others, in 2021 and 2022 was clearly a one-off caused by the mismatch between supply and demand once the pandemic ended. Instead, he envisages that inflation is most likely to run a percentage point or two above target on average.

A key question is whether central banks will accept such overshoots or will either stop short of ‘neutral’ when they cut rates or ease rates down to neutral, or even below neutral now, only to have to start hiking rates again, possibly before the end of next year. Leading the pack on this score is the Reserve Bank of Australia. It has consistently been somewhat more cautious about the room to ease policy than the market, but now the market has caught on; the first rate hike is priced into the futures curve for the second half of next year. That may well prove too early, but even so, Steven Barrow doubts that market expectations will shift notably unless inflation proves less sticky.

In the eurozone too, ECB Executive Board member Schnabel this week endorsed market pricing that suggests the next ECB move will be a hike, not a cut, albeit some distance in the future. This sounds a bit different to the rather ‘open mind’ on rates that seems to have been adopted by most other ECB members. Once again, thoughts of higher ECB rates could prove to be premature, but we might find that the market sticks with such speculation now that a key ECB figure such as Schnabel is endorsing the rate-hike view. “For our part, we have removed the extra easing that we had priced into the eurozone for next year even if we are not endorsing the idea of rate hikes before the end of 2026”, said Steven Barrow.

One key question for the market, particularly currencies, is whether this change in market psyche about the monetary policy cycle will weigh on currencies where central banks are still thought to have significant easing ahead. The Fed, with some 50 bps of further easing priced in after the recent rate cut, will be the most interesting. But note, this is not simply because the Fed is a bit further behind in the monetary policy cycle relative to many other G10 central banks. It is also a question of whether the Fed is more prepared to play fast and loose on inflation.

The fact that tariffs represent an inflationary shock for the US but are disinflationary elsewhere feeds this narrative, as do concerns over Fed politicization as President Trump readies to name a new Chair to replace Powell. In the end, it could be this concern about the Fed’s relative lack of concern over inflation that weighs more heavily on the US dollar than any corresponding move in interest rate differentials.