Inflation is stuck, central bank can't cut prices without damaging economy: El-Erian

Federal Reserve Chairman Jerome Powell is scheduled to speak on Thursday
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  • Inflation appears to be stuck above the central bank's target rate, said top economist Mohamed El-Erian.
  • Inflation in December rose to 3.4% year-on-year, more than expected.
  • If the central bank cuts inflation too quickly to 2%, it risks „crushing” the economy, El-Erian warned.

The Federal Reserve's inflation fight has hit a wall, and central bankers can't lower prices without doing damage to the economy, according to top economist Mohamed El-Erian.

The former PIMCO CEO and Allianz chief economic adviser pointed to the latest December inflation report, which showed prices rose 3.4% year-on-year. That's a faster pace than was recorded in November, when prices grew just 3.1%, the Bureau of Labor Statistics said.

El-Erian warned last year that inflation would remain stuck at 3%-4%, thanks to continued pressures in the economy, which he said would push up prices. His comments contrasted with other market commentators who predicted inflation would ease to 2% by the end of the year.

„not that [disinflation]. We're going to see, and we're already seeing cost pressures in the pipeline,” El-Erian said in an interview. Bloomberg On Friday. “I suspect we will see inflation stuck at 3% at the CPI level.

El-Erian specifically pointed to shipping disruptions in the Red Sea. That crisis could fuel further inflation by raising prices of key inflationary inputs and disrupting the supply of goods and the flow of key energy commodities.

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The U.S. job market is also resilient, something economists have warned is inherently inflationary. A tight labor market pushes up workers' wages, which can trigger a wage-price spiral, a situation in which wages and prices push each other up.

That puts central bankers in a difficult position, having raised interest rates aggressively last year to control higher prices.

Markets are betting on ambitious rate cuts this year, but there is a risk that cutting rates could allow inflation to rise again, which would hit the central bank's credibility and make it even harder for central bankers to declare the job done, El-Erian warned.

Given the circumstances, Fed officials now have two options: accept that inflation will be around 3%, or try to reduce inflation more quickly, which El-Erian previously said could „crush” the US economy. Higher interest rates threaten to overstretch financial conditions and trigger a recession, with the New York Fed now projecting a 63% chance of a recession this year.

„But this notion that pure inflation will continue is very difficult for me to reconcile with the actual data,” El-Erian said.

Other commentators on Wall Street have warned of a possible rebound in inflation as price pressures linger in the economy. Markets, however, expect inflation to move closer to the central bank's long-term target. 1-year inflation expectations fall to 2.4% In January, according to data from the Cleveland Fed.

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