Think Big: Here’s an argument for why inflation is ‘non-threatening’ at the moment
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Ever since US inflation data for April (on May 12) showed CPI rose at the fastest annual rate since 2008, the i-word has been debated ad nauseam by analysts and economists.
The key questions are: has the post-COVID recovery given rise to sustained and rapid CPI growth, and will it mean interest rates start rising quicker than everyone expects?
In research this week, CBA’s head of international economics, Joseph Capurso, addressed those questions as part of his analysis on the global inflation outlook.
The answer? Probably not.
“We conclude that inflation is not threatening at the moment,” Capurso said.
Assessing the major Western economies, Capurso said CBA expects inflation to “increase modestly” in Australia and the US.
Most importantly, “we do not expect inflation to increase so much that central banks start hiking their policy interest rates soon,” he said.
As for Europe and Japan, CBA doesn’t think inflation will even get back in the target band (between 2-3%) within the next two years.
A central component of Capurso’s analysis relates to trimmed mean inflation.
Inflation prints are typically split into two separate readings;
– headline inflation, which accounts for all components of the CPI baskets, and;
– core (or underlying) inflation, which removes more volatile items such as oil prices.
The trimmed mean is a measure of core inflation that looks to further remove volatility by removing the larger price changes (both up and down) at both ends of the data set.
Using the trimmed mean “has been shown to outperform the more conventional ‘excluding food and energy’ measure as a gauge of core inflation”, according to the US Federal Reserve.
When it comes to the current inflation outlook Capurso says the devil is in the trimmed-mean detail.
US headline inflation rose sharply in April – so did core inflation. But trimmed inflation didn’t.
“If there really was a lot of widespread inflation, trimmed inflation would have accelerated like the headline and core measures have,” he said.
At the very least, it should have jumped in annual terms given that in the prior-year period (April 2020) the world was in the process of grinding to a complete halt. But it stayed flat there as well.
Assessing the inflation outlook, Capurso considered a number of factors that are common among the major Western economies.
Fiscal stimulus remains “very loose” while household savings rates are high.
Post-COVID dynamics are also putting upward pressure on commodity prices and creating some gluts in global supply chains – two factors which can give rise to ‘cost-push’ inflation.
A notable supply chain bottleneck is the global shortage of semiconductors, which has seen carmakers cut shifts as production grinds to a halt.
But Capurso said numbers on the ground show both global exports and imports have ripped higher in the economic recovery.
“There cannot be widespread disruptions choking supply and surging trade in goods at the same time,” Capurso said.
On the ‘demand-pull’ side of the equation, Capurso looked at the outlook for global wage growth.
A key indicator for wage growth is declining underemployment – defined as workers who are in jobs but would like to work more hours.
The underemployment rate is still high in most major Western economies although it is “rapidly falling” in Australia, Capurso said.
Still, CBA doesn’t expect a rapid turnaround in wage growth off a low base, with only modest increases in the years ahead.
Then, there’s inflation expectations.
Forecasts matter because inflation is partly a function of what consumers and businesses expect it to be. If businesses think CPI is going up by 3%, they will raise prices by at least that amount.
Inflation expectations in most countries are still low, except for the US where consumer expectations for CPI growth have “increased materially”, Capurso said.
Even still, those expectations aren’t commensurate with surging inflation that will force central banks to respond.
And taking all of that into account, CBA expects the US Fed and its counterparts to hold strong to their low-rates commitments as inflation picks up through the middle of this year.
“Central banks are willing to take a risk that inflation is too high but not willing to risk that inflation is too low,” Capurso concluded.