Like any other science, economics is constantly exposed to new findings. Old certainties are thrown overboard and new rules are identified and formulated. This even applies to constants such as the inflation rate. At first glance, this is very simple: it describes the rise in the general price level. For central banks, it has always been the yardstick by which they have geared their monetary policy; after all, they wanted to achieve price stability.

Almost exactly 50 years ago, however, the central bankers had to realize that the inflation rate in its former form was not the right guide. During the oil crisis, the clever minds at the US Federal Reserve realized that the oil-producing countries were unlikely to be persuaded to reduce or increase their production volumes by US interest rate movements. As a result, they defined the core inflation rate, from which the volatile energy and food prices are deducted. This core inflation rate was not only much more stable, it also indicated more clearly when the central bank had to react.

Now it is time for a further adjustment. In the meantime, a number of other factors have emerged that influence inflation but are beyond the control of central banks. First and foremost is demographic change. Since 2020, the number of people of working age (25 to 64 years) has been falling in the eurozone and China. The direct consequence of this is that there is now a correlation between the unemployment rate and unit labor costs that we have never seen before. Until 2020, the increase in unit labor costs was roughly between one and three percent and was independent of whether the unemployment rate was seven or twelve percent. From 2020, the increase in unit labor costs reached values between 2.5 and 6.5 percent from an unemployment rate of below seven percent, because the eurozone is on the verge of a recession but the unemployment rate remains low. Obviously, employers have to pay high wages even in a weak economic environment in order to attract workers at all. Accordingly, central banks would have to raise interest rates even more than before in order to push down inflation.

For companies, this would be a double burden and a medium-sized disaster. Central banks should therefore factor out a demographic-related inflation component, as they once did for energy and food. In practice, this would mean that the ECB, Fed and co. would abandon the two percent inflation target. In difficult demographic times, three to four percent is much more realistic. The increasing restriction of free global trade and the desire of many governments to make their economies more self-sufficient (keyword: European Chips Act) are also contributing to this development.

If the central banks really do come to terms with this idea - and we assume they will - then this also means that they will be increasingly reluctant to raise interest rates. Specifically with regard to the current phase of interest rate hikes, we expect that the fall in inflation rates and rising long-term interest rates will provide enough evidence for central banks to stop raising interest rates. This will have a positive impact on equities, investment funds, real estate and gold, which traditionally benefit during periods of low interest rates.

Capital market outlook