Uncommon truths: Should we be worried about inflation?

Markets appear to have lost faith in the Fed’s desire to fight inflation. Globally, inflation remains above target but there is no clear trend. However, cyclical forces could push it higher over the coming years. 

Three major central banks met last week. They all remained on hold, as expected, but market reactions varied. The BOJ announced what my Tokyo colleague (Tomo Kinoshita) described as a hawkish hold at 1.00% and the Bloomberg market implied path of BOJ rates ticked up (Tomo now favours a hike in October). Just as important, the yen strengthened the day before the meeting, with a suspicion of intervention, which could be interpreted as a sign of tightening. 

The BOE decision to hold at 3.75% was the result of a 6-3 vote, with three members of the MPC (Monetary Policy Committee) voting to hike (two of those three had voted for a hike at the previous meeting). MPC member statements suggested a split between those believing it would be prudent to hike in the face of volatile energy prices and those emphasising the belief that policy is already restrictive and that domestic inflation pressures are easing, which could allow further easing if energy prices stabilise. Market reaction was muted, with little change in the implied path of BOE rates (a hike is expected in November or December).

The Fed meeting had the biggest impact. The decision to hold at 3.50%-3.75% appears to have been interpreted by markets as a dovish hold, despite the fact that three members of the FOMC voted for a rate hike (versus none at the previous meeting). Treasury yields jumped, with all of the movement focused on the inflation component (the rise in the 10-year yield was almost equal to the rise in the breakeven inflation rate). The market implied path of Fed policy rates is now lower than it was, with the suggestion that the first hike will come in October or December (versus September prior to the meeting). 

On that basis, the market seems to fear the Fed is behind the inflation curve. Is that fair? First, it is worth noting that the median forecast of FOMC members suggests the Fed’s neutral policy rate is around 3.1%, implying that FOMC members believe the current policy rate (3.50%-3.75%) is restrictive. To believe the Fed is behind the curve, you would need to believe the Fed’s neutral policy rate is higher than the FOMC suggests. Personally, I think the neutral rate is in the 3.50%-4.00% range (based on the assumption that inflation will be 2.00% and that economic growth will be 1.50%-2.00% over the long term). On that basis, I would say that Fed policy is neutral. 

The second way in which the Fed could be behind the curve is if inflation is above target and is on an upward trajectory. With June headline CPI and PCE inflation rates of 3.5% and 3.7%, respectively, US inflation remains above the Fed’s 2% target. The Fed’s favoured measure of inflation, core PCE, was 3.3% in June, and core CPI was 2.6%. So, the starting point for Kevin Warsh is an inflation rate that remains above target, though the trimmed mean PCE measure, that he has advocated, is closer to target at 2.2%. 

As for the trend there is a cyclical element, as suggested by Figure 1. During recession, supply of goods & services may exceed supply, thus depressing prices. In the labour market, rising unemployment is associated with falling wage inflation. Once the economy recovers, demand and supply should move into better balance and inflation stabilise, until, in the later stages of the cycle, demand outstrips supply and price inflation rises. As the cycle advances, the jobless rate is likely to fall, driving wage growth higher. 

The current economic upswing started in most countries in the middle of 2020. It is now six years old and already longer than that of 1973-79 and close to that of 2001-2007 (based on G7 aggregate GDP). Though only half-to-two-thirds of the 1980-90, 1991-2000 and 2008-19 upswing lengths, I think this expansion is reaching the stage at which inflation pressures could start to emerge. 

Having said that, inflation is often a lagging indicator. Indeed, Figure 1 shows that the trend in wage inflation usually lags unemployment. US Unemployment peaked in November 2025 at 4.5% and has since fallen to 4.2%. That downtrend has not been strong enough or long enough to yet cause an uptick in wage inflation. However, if unemployment continues to fall, history suggests that wage inflation could pick up over the next year or so (the lags are variable). 

Another cyclical force to watch is house price inflation. There are tentative signs of an upturn in US house price inflation and history suggests there is a 12–18-month lag between house prices and the shelter component of the consumer price index.

Hence, cyclical forces could drive US inflation higher but that seems more likely to be a 2027 H2 event. What about the rest of the world? Figure 2 suggests that headline and core inflation rates are close to or above the 2% level in the countries shown (except China), though with no obvious general tendency. There are signs of an uptrend in China (from a low level), while the UK shows signs of a downtrend. 

When it comes to non-cyclical forces, the most obvious risk is prolonged closure of the Strait of Hormuz and the Red Sea. Though the Brent first future price, at around $90, is above the pre-war level, it is well below the $120 seen in March and April. To provoke a durable uplift in inflation, I believe the oil price would need to keep rising beyond $120. That could happen if energy flows remain substantively reduced into Q4, but that is not our base case (though the situation remains volatile). On the other hand, once energy flows restart, the departure of the UAE from OPEC+ could boost global supply and depress prices. 

The other immediate non-cyclical force that I touched upon last week is the potential effect of the building El Nino on crops, and therefore on agricultural prices in late 2026/early 2027 (see Hot, Hot, Hot!). 

Many investors have mentioned the effect of AI on inflation, by which they mean the inflationary effect of rising technology component prices. That could become a factor but is hard to detect right now. Further, I would expect the opposite effect if AI started to deliver productivity gains (see Is AI delivering?). 

Finally, demographics could provide a steady disinflationary effect. Global population growth is easing, and I expect that to be associated with lower inflation over the coming decades, notwithstanding cyclical swings (see Don’t shoot the messenger). 

Overall, inflation remains above target in most countries but there is no trend. I think the situation in the Middle East presents the greatest upside risk, while other non-cyclical factors appear balanced. As for the economic cycle, the upswing is well advanced and that could bring higher inflation over the coming years. That may suggest the window of opportunity to cut rates is closing (with the BOE an exception, in my view) and could eventually bring general tightening. 

Unless stated otherwise, all data as of 31 July 2026. 

Investment risks 

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.