This week's US CPI release was much stronger than expected. Headline inflation (measured as the year-on-year change in the CPI) was at its highest level since September 2008, and core CPI inflation (excluding food and energy) was the highest since 1996. This has reinforced fears of a return to the stagflationary conditions of the 1970s, when high unemployment and high inflation coexisted for several years. Rising commodity prices, supply chain issues (such as semiconductors), declining global trade, and trade rigidities resulting from Covid restrictions are cited as reasons why we should be concerned that the rise in inflation is more than transitory.

There are a number of points to bear in mind with regard to the published data:

1. Inflation was expected to rise sharply in April anyway due to the base effect: year-on-year comparisons are easy for April and May because the CPI experienced a sharp decline at this time last year. This effect will disappear in the coming months.
2. The impact of the base effect will peak in May, after which it will diminish as the year progresses, so if inflation remains high, it will be for other reasons. The May CPI report will be released on June 10, so market jitters about inflation are likely to continue for at least the next couple of months.
3. The data is revised frequently. Given the unusual circumstances of last year, the revisions may be quite significant. Yesterday's impact may prove to be minor once the final data is released.
4. The June CPI report will be released on July 13. Only then will it become clear to what extent higher inflation has been driven by the base effect or other factors. However, uncertainty will remain. Only if inflation falls rapidly and remains low thereafter will fears subside.
5. While our fundamental view is that inflation will fall back to levels consistent with the Federal Reserve's targets, upside risks have increased.
6. Central banks have struggled for at least the past decade to increase CPI inflation despite exceptionally accommodative monetary policy. It is somewhat ironic, then, that now that some inflation has returned, nerves are on edge. While there may be some short-term jitters, inflation that is structurally a little higher over the next 10 years than it has been over the past 10 would not be a bad thing. For example, it would help reduce the real burden of debt: government, households, and businesses.
7. Several Federal Reserve governors and regional bank presidents have reiterated a consistently moderate message in recent months. Even if inflation is slightly above target, this is not a major concern, especially now that there are eight million fewer people employed than at the pre-COVID peak. In addition, the Fed has emphasized the importance of the distribution of unemployment across different strata of American society, which also offers a high degree of flexibility.

The risks of persistently higher inflation have certainly increased recently, and it is natural to worry that the temporary factors pushing up inflation will not decline as much as pure statistical models indicate. However, our expectation is that inflation will ease to more comfortable levels in the second half of the year. This will not become apparent until mid-July. Until then, markets are likely to be sensitive to news flow that is perceived as supporting the high inflation hypothesis. If we are wrong and inflation is persistently higher, we expect the Federal Reserve to be patient in withdrawing stimulus.