Central Bankers Misguided in Pursuit of Rate Hikes

Central bankers around the world are facing pressure to raise interest rates in response to high inflation. However, according to some experts, this approach is misguided and could have unintended consequences. Andrew Bailey, the governor of the Bank of England, has stated that inflation risks are 'on the upside,' but others argue that sustained tightening is unnecessary and a mistake.

The recent surge in oil prices, driven by the ongoing conflict in Iran, has contributed to concerns about inflation. However, data shows that high oil prices alone do not fuel true inflation; they instead drive substitution, mostly dampening luxury-goods demand. In the UK, for example, Consumer Prices Index including owner-occupied housing costs (CPIH) rose from 3.2% year-on-year in February to 3.4% in March, but quickly sank to 3% in April and remained steady at 3.1% through July.

A similar trend is observed in the US, where CPI climbed from 2.4% year-on-year in January to a high of 4.2% in May, but slowed to 3.5% in June and 3.4% in July as energy prices plummeted. Excluding energy, inflation was 2.5% in July, lower than the pre-war level of 2.6%. Central bankers should focus on the true drivers of inflation, excessive money creation, rather than stressing about rocky commodity markets.

While rate hikes may not have an immediate negative impact, they could eventually flatten or invert global yield curves, choking lending and stalling economies. As Nobel laureate Milton Friedman taught us 60 years ago, inflation is always a result of too much money chasing too few goods and services.