Inflation and the economy: a delicate balancing act

When I sat down to write this article, the most eye-catching event on the annual calendar of global monetary policy authorities was about to get under way. Analysts agreed the headline speaker at the US Federal Reserve conference in the mountain resort town of Jackson Hole, Wyoming — Fed chairman Jerome Powell — could set the tone for months to come.

Market participants were expecting Mr Powell to make the case for ploughing ahead with interest-rate increases to curb decades-high inflation, a stance that could take the wind out of the stock rally that took off in mid-June.

This would be consistent with a series of hawkish comments from Fed governors and Federal Open Market Committee (FOMC) members in recent days, notably Neel Kashkari of the Minneapolis Fed and James Bullard of the St Louis Fed.

We beg to differ. We believe that even though inflation has reached its peak and is declining, especially in the US, it remains a high risk in many countries. But how high a risk is it? We conducted a study using Global Inflation Heat Map analysis, tracking inflation in 43 countries to see what direction it was heading. It showed that the inflation rate in July started to decline.

The simple average fell from 15.2% in June to 11.5% in July, while 12 of 43 countries started seeing inflation decrease in the most recent month, indicating that the peak has already been reached.


When inflation begins to decline, the next question is how is the current global economy doing? According to the flash purchasing managers’ index (PMI) figures for leading economies, business activity in the US, Europe and Japan fell in August. This points to a sharp slowdown in global economic growth as higher prices are weakening consumer demand while the war in Ukraine is scrambling supply chains.

The composite PMI for the US economy, measuring activity in both the manufacturing and services sectors, was 45.0 in August, down from 47.7 in July. That marked the second consecutive month with a decline and was the lowest reading since the coronavirus pandemic started. Business activity in Europe also declined for a second month in a row amid a renewed rise in energy prices over uncertainty about Russia’s willingness to maintain its already reduced supply of natural gas ahead of the winter heating season.

The composite PMI for the euro zone fell to 49.2 in August from 49.9 in July, reaching an 18-month low. Manufacturing output fell for a third straight month, while the services sector narrowly avoided a contraction. Private-sector activity in Japan and Australia also declined in August for the first time since a wave of new Covid infections at the start of this year.

The PMI trend was the same as for other economic indices that were also beginning to show signs of a slowdown. In China,

weak retail sales and industrial production index moved the central bank to cut interest rates. And on Thursday, the government stepped up its economic stimulus with a further 1 trillion yuan (US$146 billion) in funding largely focused on infrastructure spending.

Nevertheless, economists say global growth is likely to remain sluggish. In Europe, the economy contracted in many countries in the second quarter while inflation continued to rise. In the US, retail sales were flat in July, while second-quarter GDP contracted.

The most important figure, though, is the contraction of Chinese imports from key markets (such as Europe and the US), which we project to lead to further slowdowns in the exports of major economies going forward.


Meanwhile, other risk events are emerging. These include the impact of global warming on agricultural, industrial production and transport around the world. In the first six months of this year, the world was at its hottest on record, according to statistics from the US National Oceanic and Atmospheric Administration.

Water levels in large rivers in China such as the Yangtze, in the US (the Sacramento, Colorado and Missouri) and Europe such (the Rhine, Po and Danube) were all below 90% of normal levels, according to a Financial Times report.

This condition has led to a shortage of electricity in China, where demand for air conditioning has jumped amid an extended heat wave. Major factories in Sichuan such as Toyota, the giant Chinese battery maker Contemporary Amperex Technology Co Ltd, as well as solar cell plants, had to temporarily cease production, while homes and businesses were told reduce the use of air conditioners.

In the US, historically low water levels in the critical Colorado Basin prompted federal authorities to cut the water allocations for Arizona and Nevada by 21% and 8% respectively. Meanwhile, in Australia, New Zealand, Italy and South Africa, drought and wildfires have been a problem. Overall, the insurer Swiss Re says climate-related damage has cost it more than $35 billion, a 22% increase over the 10-year average.

While the global economy faces increasing risks of a slowdown, interest rates remain the main concern of the financial markets. Fed officials continue to signal a get-tough approach to inflation, leading markets to believe they will approve a rate hike of 75 basis points when they meet on Sept 20 and 21.

However, we believe that given the continued economic slowdown worldwide, the Fed should not raise interest rates so aggressively.

The big picture indicates that the global economy is starting to slow while inflation may begin to decline. But if interest rates are increased further to fight inflation, it might not create good conditions for investing and could worsen the economic slowdown. Businesspeople and investors, please be careful.

Piyasak Manason is senior vice-president and head of the wealth research department at SCB Securities, email

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