Responses to inflationary pressures

Recession fears have eased substantially in recent months in response to a raft of stronger-than-expected economic data. But this threatens to keep inflation higher for longer. Central banks appear set to keep tightening policy until the data have turned, to remove any doubt that inflation will head back to target.

This will likely require a painful downturn, the severity of which probably depends on how persistent inflationary pressures prove to be. Global markets have been volatile in response to these dynamics, with initial optimism in response to the improved growth outlook quickly – and aggressively – giving way to concerns about higher policy rates and the associated negative growth implications later in the year.

In Australia, the Reserve Bank has taken a hawkish turn, and the ‘narrow path’ to a soft landing for the economy has become seemingly narrower, following unexpectedly strong inflation data. The next labour force survey will be crucial for the policy outlook as any further deterioration in labour market outcomes could see the household sector become increasingly cautious.