Stubbornly high inflation in Europe and the US means that central bankers won't be swapping their hiking boots for ballerina slippers just yet when it comes to interest rate hikes.

Oh, those were the days when central bankers could describe elevated inflation as temporary! At least that was the view of economists and European Central Bank (ECB) President Christine Lagarde less than twelve months ago.

Then in February came Russia's attack on Ukraine, and it quickly became apparent the invasion was likely to have dramatic consequences, and not just for oil and gas prices.

Too Timid ECB

While the Bank of England (BoE) and the US Federal Reserve (Fed) had long since begun to turn the interest rate screw, the ECB undertook its first interest rate hike only in June.

But the effect so far has been nil. Inflation in Germany and the eurozone is now in double digits, the highest since the 1970s. Subsequent price developments are pointing to a further 75 basis point increase at the next ECB Governing Council meeting on October 27.

On the stock markets, any glimmer of hope the Fed might reduce or slow its rate moves is rewarded with rising prices. But the minutes of the last Federal Open Market Committee (FOMC) meeting published Wednesday give no indication that will happen anytime soon.  

As Long as Necessary

Conversely, US monetary authorities do not want to slow down their battle against stubbornly high inflation. The goal of bringing inflation in line with its 2 percent target will not be abandoned and will stay the course, even if the labor market weakens. That means for now policy aimed at fulfilling the Fed's dual mandate of «maximum employment, stable prices, and moderate long-term interest rates» is tilted towards fighting inflation. That means that monetary policy must remain restrictive for some time and for as long as necessary.

According to economists, data suggests the momentum of the US economy is slowing. However, there are no signs of recession and the economy is performing better than in Europe. The idea the economy could achieve a «soft landing» appears to slowly be taking hold.

The latest US inflation figures of 8.2 percent, once again dashed hopes of a slowdown. Although inflation weakened slightly, the core rate rose. On Friday, retail sales are scheduled for release and will be gone over with a fine-tooth comb for slowing consumer spending. Right now, indications are the Fed will raise interest rates by 75 basis points in November and by another 50 basis points in December.

Worst Case Scenario

In Germany, economic expectations have recently been revised downward yet all estimates continue to be based on the optimistic scenario. An energy shortage for gas and electricity in winter is not factored in. If this were to happen, it would probably lead to a severe economic slump.

Two days ago, the International Monetary Fund (IMF) also warned of a high risk of recession with rising interest rates and the strong dollar having serious consequences worldwide.

Economic Domino Effect

There could be a rapid and disorderly adjustment of prices on the markets which would hit existing vulnerabilities. As market liquidity has declined, it has increased its vulnerability.

The strong dollar is causing problems, particularly in emerging markets, while the weakening of other currencies was creating additional problems for them. This could lead to an economic domino effect and defaults, the IMF fears.

Dear, oh Dear

Speaking of the worst-case scenario, the past two weeks in Great Britain have been dominated by the turbulence triggered by «Trussonomics». The spending and tax plans of the newly installed Prime Minister Liz Truss and Finance Minister Kwasi Kwarteng have severely shaken the markets' confidence in the public finances. This caused a drop in the price of government bonds, rising mortgage rates, and a decline in the value of the Pound.

All that leaves the BoE in a quandary. It had to pump money into the bond markets, while it wants to pursue a restrictive course with higher interest rates. At the next meeting on November 3 on Threadneedle Street in London, economists are expecting an interest rate hike of a full percentage point, with a minority expecting 1.25 percentage points. 

The media even paid close attention to the reaction of King Charles III at the weekly audience with the head of his government. There, Truss was greeted by the monarch with the words, «Back again? Dear, oh dear».