In the U.S. and Europe, underlying inflation has stopped falling or edged higher recently, weakening the case for rate cuts
4 min
Inflation is proving stickier than expected in the U.S. and Europe, creating a headache for central bankers and sowing doubts on whether investors are too optimistic about the world economy.
The decline in inflation from highs of around 9% to 10% across advanced economies in 2022 represent the easy gains, as supply-chain blockages eased and commodity prices, especially for energy, normalised.
The “last mile” is proving tougher . Underlying inflation, which excludes volatile food and energy prices, slowed to 3% in the second half of last year across advanced economies but has since moved up to 3.5%, according to JP Morgan estimates.
That is forcing investors to rethink bets that inflation would steadily decline to central banks’ targets, generally around 2%. There are even concerns it could surge again, mirroring the second wave that characterised the high inflation of the 1970s.
Economists’ and central banks’ forecasts of sustained falling inflation depend on “strong gravitational forces that are not yet validated in global labor costs, short-term expectations, or in recent signals from commodity markets,” JP Morgan wrote in a note. Services inflation remains elevated while goods prices, which had fallen last year, are now moving higher, it noted.
Central bankers say they expected the last mile of falling inflation to be bumpy. Yet they are also signaling their willingness to wait before cutting interest rates. Fewer, or no, rate cuts would have sweeping repercussions for the global economy and markets, whose recent rally began after a narrow majority of Federal Reserve officials recently reaffirmed projections to cut interest rates three times this year.
On Friday, the U.S. Commerce Department reported that the price index of personal-consumption expenditures, the Fed’s preferred indicator of inflation, rose a relatively tame 2.5% in the 12 months through February, up modestly from 2.4% in January. Beneath the surface, the trend was less comforting. The index excluding food and energy climbed by 3.5% on an annualised basis in the three months through February, up from around 2% late last year.
“These shorter-term inflation measures are now telling me that progress has slowed and may have stalled,” Fed governor Christopher Waller said in a speech Thursday, before the latest inflation data.
“In my view, it is appropriate to reduce the overall number of rate cuts or push them further into the future,” Waller said.
Fed Chair Jerome Powell struck a more balanced note Friday, saying inflation is on a sometimes bumpy path toward 2%, and strong economic growth allows policymakers to wait. “Is progress on inflation going to slow for more than two months?…We’re just going to have to let the data tell us that,” Powell said in an interview at the San Francisco Fed.
Joachim Nagel , president of Germany’s Bundesbank and a member of the European Central Bank’s rate-setting committee said in late February that underlying inflation in the eurozone was still 2 percentage points higher than its 1999 to 2019 average.
“If we reduce interest rates too early or too sharply, we run the risk of missing our target,” and might need to raise interest rates again, he said. He highlighted a recent International Monetary Fund report that found four out of every 10 inflation shocks since the 1970s had yet to be overcome even after five years.
In Italy, underlying inflation climbed to 2.4% in March from 2.3% the previous month, according to data published Friday. French headline inflation cooled to 2.3% in March, but services prices remained sticky, rising by 3% from a year earlier.
Why is inflation proving stubborn?
Despite the sharp interest-rate increases of the past two years, economic growth is resilient, especially in the U.S. The Atlanta Fed said Friday its real-time indicator of first quarter U.S. economic growth ticked up to 2.3% from 2.1%. Consumer spending, adjusted for inflation, increased by around 5% on an annual basis in February, the Commerce Department said.
“The unexpected strength of real consumption” means “there is still no rush to cut interest rates,” said Paul Ashworth , an economist with Capital Economics.
While Europe’s growth has stalled since late 2022, recent business surveys suggest the outlook is brightening. Meanwhile, job creation has been strong on both sides of the Atlantic, and wage growth remains high, partly reflecting tight labor markets. Wages are an important input to services-price inflation in the eurozone, which has been running at a 4% annual rate since November.
March inflation data for the entire eurozone will be published on Wednesday. ECB officials have indicated they could start to cut interest rates in June from the current 4% level, while the subsequent pace of cuts after that is unclear.
Central banks themselves may be inadvertently adding to inflation pressure. By signaling a pivot toward interest-rate cuts last fall, they pushed global borrowing costs down and asset prices up, supporting spending.
Some factors favour inflation declining further. In both the U.S. and Europe, a surge of immigration could help keep a lid on wage increases.
The U.S.—but not Europe—is also seeing big increases in productivity, that is output per worker, which helps to offset high wage growth. It is unclear, however, how long that will last. The pandemic might have changed how Americans work and use technology, but “once we have made those changes, they’re done, so I don’t see this as a driver of sustained productivity growth,” the Fed’s Waller said.
Meanwhile, oil prices have risen recently, which could push up headline inflation.
To offset a slumping property market, China has dramatically boosted manufacturing capacity and exports, which have weighed on global goods inflation. But its export prices have recently started to increase, according to JP Morgan.
If central banks react to stubborn inflation by backing away from rate cuts, that would put pressure on both heavily indebted governments and employers. That could test central banks’ will to finish the last mile and push inflation all the way to target.
Higher government spending on defence and green energy, and geopolitical tensions that crimp global trade, are likely to pressure central banks to tolerate higher inflation over the coming years, according to a Brookings Institution paper published in March.
“A strengthening of central bank independence combined with a more credible public debt policy is likely needed,” said the paper, by economist Kenneth Rogoff of Harvard University and three co-authors.
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Strong family financial planning can help reduce taxes and support younger generations. From intrafamily loans and asset gifts to inheritance disclaimers, strategic cooperation can create meaningful financial benefits—when families have the trust and structure to make it work.
4 min
Happy is the family whose members—parents, grandparents and grown children—trust each other enough to cooperate on shared goals, especially financial ones. When that is truly the case, Uncle Sam’s tax rules can help as well.
This matters especially now that mortgage rates are above 7%, and many families are looking for ways to help younger members. If the elders have resources and are confident younger ones can cooperate, a family loan could make homeownership possible while providing the elders with a useful income stream.
Other strategies can actually lower taxes, such as when funding 529 plans or Roth IRAs, or when someone inherits a traditional IRA with required withdrawals larger than they will need.
Here are three strategies useful for functional families.
It is perfectly legal for families to lend money to a relative for a down payment or even a private mortgage.
But it is important not to cut corners, says Ryan McKeown, a CPA with Modern Wealth Enhancement in Minnesota. If the loan is for a down payment, be honest with the mortgage provider and have a formal agreement. The lender owes tax on the interest payments received.
If the loan is for a private mortgage, both sides should have legal representation with a formal written agreement, including payment terms. The lender owes tax on the interest, and the borrower often can deduct it if he or she itemizes.
To avoid IRS trouble, the interest rate shouldn’t be lower than the agency’s Applicable Federal Rate at the time of the loan. Currently that is about 5% for loans longer than nine years; about 4.5% for loans three to nine years; and about 4% for loans three years or less. Currently, traditional mortgage rates are generally above 7%.
In addition, the lender could use the $19,000 annual gift-tax exemption (described below) to forgive some or all of the interest or principal annually. If both lenders and borrowers are married, that is up to $76,000 a year. There is no tax for the borrower on such forgiveness, because it is from a gift.
If you’re going this route, McKeown advises against having a fixed plan to forgive the debt. Instead, do it in one-off letters specifying the amount—and keep careful records. Otherwise the IRS might try to treat the loan as a taxable gift.
Powerful tax-saving moves for families often use gift-tax provisions. Under current law, anyone can give anyone else up to $19,000 of assets annually, free of gift tax. That means a married couple with three grandchildren could give them a total of $114,000 in 2026.
The gifts can be cash or other assets, like stock. For noncash gifts, the cost basis—which is the starting point for measuring taxable gain after a sale—“carries over” to the recipient. So if someone buys $1,000 of stock and gives it away when it is worth $5,000, the recipient’s cost basis is $1,000. If the recipient later sells the shares for $8,000, the taxable gain is $7,000.
Here’s an example showing how gifts could save a family taxes. Grandma is a widow of modest means, while her child and spouse have prospered. The couple has two children, and they want to contribute $5,000 to a 529 college-savings plan for each—but they need to sell stock to do it. Their tax rate on the sale would be 18.8%, and they would need to sell about $11,000 of stock.
However, Grandma’s federal tax rate on the stock sale is 0%. If the couple gives $10,000 of shares to Grandma, she could sell them, pay no tax, and fund the grandchildren’s 529 plans. This saves about $1,000 of tax.
These moves are legal, and they could be used in other ways, such as to help a young person fund a Roth IRA.
But trust among family members is essential: Under the law, givers can’t put conditions on a gift. Grandma could use her stock proceeds to take a cruise, but she makes 529 contributions instead.
Mark Sellner, a retired tax attorney and CPA living in Sarasota, Fla., uses this strategy. His children sell stock he gives them and fund 529 plans for his grandchildren.
The family’s tax savings aren’t huge, but he likes other benefits. The sales by his children don’t boost his adjusted gross income, which in turn could raise his Medicare Irmaa premiums or his 3.8% surtax on net investment income.
Sellner doesn’t worry about his children using the funds for another purpose.
“There can’t be any strings attached to gifts. Of course, it is up to us to decide whether to make them in the future,” he says.
Two caveats: The “kiddie tax” applies to most children under age 24, and it is levied at the parents’ rate on investment income above $2,700 in 2026. Consider this before making gifts to a young person.
Investors who give away stock also forgo the step-up, an important provision that exempts assets held at death from capital-gains tax.
Sellner knows he’s losing a step-up, but says, “The children could use a little more now. Why should they wait 20 years to get it?”
A disclaimer is a highly useful strategy in which one heir renounces an inheritance in favor of another heir. Assuming family members cooperate, this can save taxes.
Here’s one example. Dad died and had a large traditional IRA that he left to Mom. She has enough assets and income to cover her expenses, and she lives in a state with a stiff estate tax. The inherited IRA would put her estate over the threshold.
Also surviving are three young-adult children. If Mom disclaims all or part of Dad’s IRA within nine months of his death, that amount could go directly to the children. They will have 10 years to empty the account, and the family as a whole will likely save estate and income taxes.
Disclaimers have many key details, especially regarding beneficiary documents. Although heirs have great freedom in choosing what assets to disclaim, the rules about who gets disclaimed property are rigid. It is best if the original owner names tiers of heirs so that if one disclaims, the next recipient is clear.
