Era of 'cheap money' under more threat as US inflation hits 39-year high of 7%

Thursday, 13 January 2022

US prices rose 0.5 per cent in the month of December, taking the annual rate up from 6.8 per cent in November.

Annual inflation in the United States has climbed to a near 40-year high of 7 per cent according to the US Labour Department, raising the prospect that the era of “cheap money” may draw to a more sudden close.

The inflation rate is likely to heighten nerves around the world, including New Zealand, over the extent to which central banks may have lost control over prices.

New Zealand’s Reserve Bank tends to pay less regard to inflation that is caused by higher prices for imported products when setting monetary policy.

But the US inflation jump is firming-up expectations that the US Federal Reserve will need to raise interest rates several times this year, if it is to avoid high inflation becoming baked into wage claims.

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Those rate rises could be expected to have a knock-on effect on interest rates in New Zealand.

Reserve Bank governor Adrian Orr emphasised the degree to which the local economy was hostage to global trends in November, saying it had only played “a bit role” in unsustainable house price rises and that New Zealand was a “price taker” when it came to determining the level of long-term interest rates.

Investment bank Goldman Sachs forecast ahead of the US inflation data that the US Federal Reserve would raise its official cash rates four times this year.

The current New Zealand Reserve Bank track would see its own official cash rate rise from its current level of 0.75 per cent to reach 2 per cent by the end of the year, starting with what is expected to be a 25 basis point rise next month.

Prices in the US have risen on the back of a strong fiscal and monetary policy stimulus, compounded by a shortage of goods and services attributed to supply chains problems that are now taking a turn for the worse due to the wave of Omicron infections sweeping the country.

Despite inflation proving stronger and more persistent than was assumed last year, the Federal Reserve and many investors are picking that it is now near a peak.

Investors on Wall Street reacted calmly to the US inflation data which was as had been expected, leaving the S&P 500 share index in mildly positive territory on Thursday, New Zealand time.

Stats NZ is due to release its estimate of inflation in New Zealand during the three months to the end of December on January 27.

That rate jumped more than expected to 4.9 per cent in the September quarter, putting it almost 2 per cent above the top of the Reserve Bank’s target band, with the central bank expecting it will peak at 5.7 per cent in the three months to the end of March.