Relief is the predominant emotion on the financial markets at the start of the new year. People are relieved, because the worst-case horror scenarios of gas and electricity outages have been avoided and are unlikely to occur − this winter, at least. Another reason for relief is that inflation seems to have peaked in the industrial nations, as expected. 

However, a sense of relief doesn’t mean the dangers have passed. A closer look certainly needs to be taken at inflation. Consumer price inflation has actually fallen over recent months. The total rate of inflation currently stands at “just” 6.5 percent in the USA and at 8.6 percent in Germany. This is mainly due to an easing of the energy price situation: global oil prices have dropped down to a level that’s no longer above the previous year’s level. And gas prices have also decreased sharply over recent months.

But unfortunately, this hasn’t resolved the issue of inflation in industrial nations. The underlying core rate of inflation – which excludes energy and food prices – is still well above the targets set by the respective central banks in many countries and also much higher than their key rates. Taking interest rates for money market investments as a benchmark, inflation-adjusted interest is well into negative territory in some places. The real interest rate, thus defined, stands at –1.5 percent in the USA, at –2.5 percent in Europe and at –1 percent in Switzerland. 

A central bank can only combat inflation effectively if this real interest rate is above zero. In other words, core inflation must fall very sharply, or the central banks will thwart financial market hopes once again by making further sharp interest rate hikes. 

The chance of core rates of inflation falling significantly – in addition to overall rates – is quite slim. That’s because they’re still currently climbing in most industrial nations. The situation for the financial markets is complicated by the fact that wages and most other cost elements are set to continue rising. If the central banks manage to control inflation rates, which are measured by companies’ selling prices, there will still be a transition period with significantly declining margins and falling corporate profits. 

Rising interest rates and dwindling company profits are not the stuff that stock market dreams are made of. Some analysts will have to adjust their forecasts. Until that happens, we will remain cautious. 

But we don’t doubt that the central banks will succeed in bringing the spectre of inflation under control over the course of the year. Only then will the path for an upturn in the economy and on the financial markets be clear once again.