Financial markets are increasingly on edge about the risk of inflation taking hold and pushing up interest rates.

It's had a negative affect on the New Zealand sharemarket with many local stocks interest-rate sensitive, including the large energy utility companies as well as growth stocks.

The S&P NZX50 index has underperformed other markets this year for this reason.

In the US higher-than-expected inflation data for April provided financial markets a wake-up call.

Consumer prices jumped by 4.2 per cent in the 12 months through to April, up from 2.6 per cent in March, making it the biggest increase since 2008.

US bond yields went up and the US stock market fell sharply in response.

Locally economists are bringing forward their expectations for central bank rate hikes.

ANZ said it is now forecasting the RBNZ will begin raising the OCR in August 2022, with gradual but steady increases thereafter taking the OCR to 1.25 per cent by the end of 2023

The latest ANZ Business Outlook survey showed measures of inflation pressure have soared, said ANZ chief economist Sharon Zollner.

"Reported costs are through the roof and pricing intentions are in uncharted territory, with a net 58 per cent of firms (67 per cent of retailers) reporting they intend to raise their prices".

One question is whether the US CPI result is a sign of things to come for the US and the world economy.

It is widely accepted that inflation will keep rising this year as the world recovers from Covid-19.

The consensus is that higher inflation will be a transitory thing - a blip higher - before returning to more subdued levels.

But what if it isn't?

Nobody doubts that there will be a surge in inflation as the world recovers from Covid-19 and supply chain constraints continue to bite hard.

However, two camps have emerged; those who think higher inflation will soon pass and those who say it will be more enduring.

The US inflation data will have the "transitory" camp sweating.

"It's the main thing that we are debating," Hamish Pepper, fixed income and currency strategist at Harbour Asset Management, says.

"Yes, we can see that inflation is moving higher," he said.

"The big question is how long does it stay higher and will it remain there long enough for central banks to act," Pepper said.

As it stands, New Zealand's Reserve Bank has remained steadfast about keeping interest rates low while the economy recovers from the shock of Covid-19.

Most other central banks around the world are of the same view.

In the near term, the inflationary pressures are there for all to see.

Supply issues, freight costs, goods shortages plus higher commodities prices - including oil - all fit into the transitory inflation argument.

"Where the debate begins is the degree to which it persists," Pepper says.

"Those supply issues may take a lot longer to resolve - another year, maybe.

"Once we get through that temporary costs push, maybe economies will be in a good enough position to generate inflation themselves.

"What has happened in recent months is that the transitory camp has started to worry a bit more."

If higher inflation persists, it will then become a matter of inflation expectations.

"That's when businesses start to think differently about how they set their prices and how employees start thinking differently about how they are going to enter their wage negotiations," Pepper said.

His take on the great inflation debate is that it's split.

"But I think the momentum has favoured more for those in the camp that says inflation could be more persistent than is currently been factored in," he said.

Analysts and economists are not quite aligned with the signals coming from the financial markets.

Domestically, the expectation is that annual inflation will hit 2.5 per cent this year before sinking below 2 per cent by the middle of next year.

But those inflation expectations are not squaring with the interest rate markets, which are pricing in a 50/50 chance of a rate hike by next May.

New Zealand inflation-indexed bonds yields are also up at around 2 per cent across a number of maturities, again not quite in keeping with a temporary inflation blip.

If stronger inflation outcomes persisted, the Reserve Bank could start to wind back its bond-buying programme a bit quicker, Pepper said.

He thinks the New Zealand economy could be in a much better state than people assume.

That's backed by local bond yields creeping up, based partly on a string of better than expected data but also on firming yields offshore.

Key 2031 government bond yields are up at 1.9 per cent from 1.6 per cent two weeks ago.

David McLeish, senior portfolio manager and head of fixed income at Fisher Funds, said higher inflation outcomes will put pressure on central banks to hold the line.

"The narrative right now is that there are still very mixed messages," McLeish said.

"You are seeing from central banks around the world that there is no hurry to put the foot on the brake of an economy to slow it down because of some form of overheating," he said.

He said the market's reaction to US inflation was not big enough to suggest that it would put pressure on central banks "but the CPI print was potentially a shot across the bows".

McLeish talks of the three Ds - elements that will suppress inflation in the long-run - debt, aging demographics and disruptive technologies.

He believes that inflation will be transitory but investors will be keeping a wary eye on whether it becomes something more than that.

"We all know that inflation expectations quite often can dictate future inflation outcomes so if people believe that inflation is actually rising, will continue to rise, and will be sustainably higher, then that will almost be a self-fulfilling prophecy and create high inflation going into the future."

The Reserve Bank's monetary policy committee, at its April 14 review of the official cash rate, said that in line with "least regrets" framework, it would not remove monetary stimulus.

"Given that uncertainty remains elevated, gaining this confidence is expected to take considerable time and patience," it said then.

McLeish said it appears that central banks' highly accommodative interest rates settings look safe. For now.

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