‘Team Transitory’ hasn’t given up hope of winning the great inflation debate.

That was the tag given to everyone -- from Federal Reserve Chair Jerome Powell on down -- who expected pandemic price-spikes to be shortlived. With inflation still breaking records all over the world, they essentially lost that argument. 

But there remain plenty of economists who argue that the shock will soon fade, as supply blockages ease and energy costs stabilize. Some warn that central banks are in danger of making a big mistake by raising interest rates too aggressively even as price pressures show signs of peaking.

With inflation now exceeding 8% in the euro area, and expected to stay above that level in the US when May data comes out on Friday, here’s a roundup of some of the main arguments laid out by Team Transitory 2.0.

Too Tight?
Central banks argue they can raise interest rates at a pace that allows their economies to achieve what’s known as a soft landing. Skeptics say they’ll tip their economies into recession by tightening too much, with inflation likely to undershoot targets again as a result.

History illustrates the risks: The European Central Bank in 2011 raised borrowing costs only to be forced to reverse them later that same year while the Bank of Japan in 2006 raised rates and had to unwind that move in 2008.  

Inventory Glut
Ongoing supply chain blockages prompted retailers to stock up on the goods they need to ensure they can meet demand. With signs that consumers are growing cautious as interest rates rise, that’s now leaving an overhang of goods that will add downward pressure on prices.

Inventories rose $44.8 billion, or 26%, for businesses on S&P consumer indexes with a market value of at least $1 billion, according to data compiled by Bloomberg of companies who reported earnings in late May. Economists at Morgan Stanley warn that the risk of an inventory glut is growing, especially in sectors such as consumer discretionary and technology goods.

Housing Falters
House prices soared in many countries during the pandemic thanks in part to central banks bringing interest rates to historic lows and pumping money into their economies by quantitative easing. While house prices aren’t always included in inflation baskets, rental costs are, and they often reflect the same dynamics.

As inflation took off in 2021, borrowing costs started going up to tame it. There are now signs that house prices are cooling. Global growth in real house prices slowed to a 4.6% annual rate in the final quarter of 2021, down from 5.4% in the previous three months, according to the Bank for International Settlements. In real terms, they estimate that global house prices exceed their immediate post-global-financial-crisis average levels by 27%, suggesting plenty of scope for a correction. As interest rates rise, so will the repayment burden on consumers.

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