Inflation has started to rise globally over the last few months. This followed a significant downward trend since the middle of 2011, which flattened out at the end of 2014. Since then it had been moving broadly sideways. Eurozone inflation was at +0.4% yoy in September, up gradually from the low point of the year of -0.2% yoy. US CPI inflation is up at 1.5% (low at 0.8% in July), while China’s CPI stood at 1.9%, compared to August’s low of 1.3%. So has inflation finally come to an inflection point? Will it rise more significantly in the coming months?
A second positive for global inflation is manufactured goods prices. They have been falling since the Autumn of 2014.
Nick Kounis Head of Macro Research
Global inflation is on the up
- Global inflation has started to move higher and will likely rise further in the next few months
- Energy price inflation will go from being negative to being positive, while global manufactured goods price deflation has faded
- Still there are reasons to think that the rise will be not be too sharp or sustained
- Economic growth, while improving, is still lacklustre, while spare capacity around the world is keeping a lid on domestic price pressures
Oil price drag is set to fade
Headline inflation is set to accelerate further over the next few months. Most importantly, the drag from energy price inflation is set to fade. We expect oil prices to rise in the coming months. However, even if they were to remain flat at current levels (around USD 50), the year-over-year change in energy prices would go from being negative to being clearly positive. This will push the overall CPI across the major economies higher. This is illustrated in the chart to the left below.
Industrial goods price deflation fading
A second positive for global inflation is manufactured goods prices. They have been falling since the Autumn of 2014 (see chart below on the right). However, over the last few months, the pace of deflation has eased and there are indications it should end before long. In particular, China, often nicknamed ‘the world’s factory’, is an important driver of manufacturing activity and manufactured goods prices. Chinese producer prices stabilised in September, while they were falling sharply at the turn of the year. The output price index of the global manufacturing PMI has also been improving and also suggests deflation is dissipating.
Turn in commodity prices and less over-capacity
What explains the change in trend for Chinese manufactured goods prices? One factor is the rise in commodity prices this year after the collapse in 2014-2015. Second, economic growth in China has also slightly improved. Finally, over-capacity has been reduced in a number of industrial sectors, so their downward pull on prices has eased.
Not too sharp or sustained
Still, we do not think the uptrend in global inflation will be too sharp or sustained. To start with, energy prices tend to have relatively transient effects on inflation. As the chart on the left shows, oil prices will likely push up energy inflation over the next few months, but the impact would tend to ease during the course of next year. In addition, there are also some restraining factors on the extent of the acceleration in manufactured goods prices. For instance, overcapacity in a number of China’s industrial sectors has come down but is a long way from being eliminated. In addition, global industry and trade growth look set to improve, but are coming from very depressed levels.
US is closest to full employment
In addition, there is still significant spare capacity more generally in many economies, which is depressing domestic price pressures. The US economy is probably the closest economies to full employment. The unemployment rate has fallen to low levels. However, according to many estimates is not yet at the level to generate strong wage pressures. Indeed, wage growth has started to show some signs of life but remains moderate. The unemployment rate has actually been flat over the last year, as strong employment growth has been matched by rising labour supply. With the labour force participation rate low and employees working part-time that want to work full-time, there may even be a little more slack in the labour market than suggested by the low level of the unemployment rate.
Eurozone and Japan facing low underlying inflationary pressures
On the other end of the spectrum, eurozone unemployment has come down but still remains high. Wage growth has actually continued to trend down, possibly also reflecting depressed inflation expectations, which are often a starting point for pay settlements. Eurozone core inflation is low (at just 0.8%) and has shown no sign of moving higher. Meanwhile, Japan’s core inflation has been slowing over recent months. It is now close to zero and the country risks renewed deflation. The strength of the yen and weak economic growth are the major culprits.
UK is a special case
One country stands out as an exception. UK inflation looks set to rise sharply in the coming months. Brexit risk has led to a sharp fall in sterling. This points to a jump in import prices, which will eventually feed through into a pickup in core goods price inflation. Taken together with significantly higher energy prices (also exacerbated by the fall in sterling against the dollar). These factors should eventually push UK CPI inflation to around 3%, which is well above the BoE’s 2% target for inflation over the medium term.