Strategy team: Charlie Hines and Kevin Gardiner
Inflation rates across most major developed economies remain low. Fiscal and monetary policies are loose, but the spring’s lockdowns resulted in substantial disruptions to both demand and supply, and resultant spare capacity.
UK inflation reversed its disinflationary trend in September, with headline consumer price inflation rising to 0.5% year-on-year from 0.2% in August, largely supported by the tapering off of the government’s ‘eat out to help out’ scheme, pushing up prices for restaurants and cafés. This follows a brief uptick in inflation between May and July – a result of pent up demand following the initial reopening of businesses. Core inflation – a measure that omits the more volatile effects of food and energy prices – trended upwards as well, rising to 1.3% in September from 0.9%. Despite this, inflation remains well below the Bank of England’s 2% inflation target, and recent announcements from its governor, Andrew Bailey, suggest that further monetary loosening may be possible.
The Eurozone moved deeper into outright deflationary territory in September: headline consumer price inflation moved more negative to -0.3% from -0.2% in August, and core inflation trended downwards as well (to 0.2% from 0.4%). These rates are significantly below the ECB’s target rate of 2% (strictly speaking, just below 2%), and arguably put some pressure on the ECB to draw up additional stimulus at its next meeting in December, particularly since a strengthening Euro – which has risen roughly 5% year to date on a trade weighted basis – makes imported goods cheaper, and will likely add further downward pressure to consumer prices.
The US looks the least deflationary of the three, and has seen headline CPI inflation continue to rise, though slowly in September (+1.4% vs +1.3% in August), with core CPI inflation stable at 1.7% - its highest level since the pandemic began. However, the rebound in inflation, reportedly partly driven by specific shortages, is expected to slow slightly as supply side issues are resolved. The Fed’s inflation target is couched in terms of the core consumer price deflator, not the CPI, but the latest data there also show the core price index moving upwards to 1.6% in August (from 1.4% in July). Recent changes to the central bank’s policy framework remain accommodative and show a flexibility in allowing inflation to run higher than the targeted 2% for a while to “make good” some of its recent shortfall. Inflation has been below Fed’s target for quite some time apart from brief periods in 2012 and 2018.
Despite bond markets registering some pickup in inflation expectations –10-year breakeven inflation rates are trending upward, albeit from a historically low level – they still suggest that inflation may remain historically subdued for some time yet. The threat of rising unemployment in coming months – fiscal support has been reduced in the UK and talks over the next US fiscal package remain in deadlock – alongside a potential reversion to tighter restrictions, remains a headwind to inflation.
For the time being, then, the forces at play seem more deflationary than inflationary, and there are few signs of an imminent change. Longer term, however, we continue to expect inflationary forces to start to dominate. Generous public policy settings may continue to spur demand even as private sector confidence revives, and we see effective demand outpacing supply – eventually. And in contrast to much received wisdom, we do not see that as a good thing. Inflation targets exist to limit inflation, not to encourage it.
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