- On 10 February it was published that US annual inflation for January was 7.5%.
- It was the highest since the early 1980s, the highest reading in four decades.
- A reading like this pressures central banks to raise interest rates, which makes financing more expensive and changes the value of assets.
On 10 February 2022 US inflation for January was published: 7.5% year on year, the highest since the early 1980s. The figure confirmed that rising prices were not an issue confined to a single country but a phenomenon affecting the world’s largest economy and therefore with consequences for all the others. In such an interconnected economy, the prices of energy, industrial goods and food pass from one country to another quickly.
A 7.5% reading demands attention to inflation even if for a long time it was not necessary. Rising prices in the United States matter in Barcelona or Madrid for very practical reasons: they influence central bank decisions, the cost of financing, the value of currencies and the price of many of the raw materials traded around the world. It is worth understanding what the figure measures and what may follow.
What ‘annual’ means
The annual rate compares prices in one month with those of the same month a year earlier. It is the usual way to measure inflation because it removes seasonal effects, and so 7.5% means that prices were, on average, considerably higher than twelve months before.
Measuring this way has an advantage and a limit. The advantage is that it allows like-for-like periods to be compared without sales, holidays or the Christmas season distorting the result. The limit is that it is an average: it does not say which products rise most or how the rise is spread between families and companies, so the figure should be read as a general indicator and not as an individual experience. The inflation felt by a family with children and a mortgage is not the same as that of an older person living on a pension, even if both hear the same figure.
A concern for every business
Inflation had stopped being a topic for economists and become a concern for any business: purchase prices, wages and margins were all moving at once. When everything rises together, it is easy to lose sight of whether the company’s real margin is improving or deteriorating.
For a company, purchasing costs may rise before it can pass them on to customers, and wages tend to be revised with a lag behind prices. That mismatch squeezes or widens the margin depending on the sector and each business’s ability to set prices. It is worth reviewing contracts, price lists and indexation clauses before the mismatch turns into a loss. Businesses with little ability to raise prices, or with long contracts at a fixed rate, are the most exposed to this lag.
The central banks’ response
A reading like this pressures central banks to act, and the usual response is to raise interest rates. For companies and families that means more expensive financing and changes in the value of assets, so it is worth following these figures as an indicator of what may come. Persistently high inflation tends, over time, to lead to higher rates; inflation that eases tends to do the opposite. Following the trend helps more than reacting to a single month.
Raising rates aims to cool demand so that prices stop rising so fast. It is a remedy that works with a delay and has side effects: it makes mortgages, loans and refinancing more expensive, and it can affect the pace of growth. That is why those with variable-rate debt or loans falling due soon do well to calculate in advance what a rise in repayments would cost them. Knowing the specific figure, in euros per month, is more useful than the vague idea that everything will cost more.
Other countries’ inflation eventually reaches one’s own economy too.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
