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2016-01-12 06:23:53
Inklings of inflation in the rich world are outweighed by downward pressure on prices elsewhere
Jan 2nd 2016
EVER since the financial crisis of 2008, forecasters have scanned the horizon for the next big disruption. There are plenty of candidates for 2016. China s economy, whose might acted as a counterweight to the slump in the rich world in the years after the crisis, is now itself a worry. Other emerging markets, notably Brazil, remain in a deep funk. The sell-off in the high-yield-debt market in December has prompted fears of a broader re-pricing of corporate credit this year.
Yet one worry is absent: financial markets are priced for continued low inflation or lowflation . A synthetic measure, derived from bond prices, puts expected consumer-price inflation in America in five years time at around 1.8%. That translates into an inflation rate of around 1.3% on the price index for personal-consumption expenditure (PCE), the measure on which the Federal Reserve bases its 2% inflation target. Ten-year bond yields are just 2.3% in America, and are below 2% in Britain and below 1% in much of the rest of Europe. The price of an ounce of gold, a common hedge against inflation, has fallen to $1,070, far below its peak in 2011 of $1,900. Yet market expectations are often confounded. Economic recoveries are maturing. Labour markets are tightening. Could inflation be less subdued than expected in 2016?
Rich-world inflation is currently depressed because of temporary influences. In America the PCE index rose by just 0.4% year on year in November but that is in large part because of a sharp fall in consumers energy prices in early 2015, which will soon drop out of the annual comparison. The core measure, which excludes food and energy prices, has been stable at 1.3% for months. It might also be somewhat suppressed by the sharp fall in oil prices, which has held down the cost of producing other sorts of goods and services. An analysis by Joseph Lupton of J.P. Morgan finds that core inflation worldwide has crept up to 2.3%, a rate that has rarely been exceeded in the past 15 years. In biggish emerging markets, including Brazil, Russia and Turkey, core inflation is above the central bank s target (see chart).
A low blow
In the view of some, lowflation is a relic of the past. Even the euro zone is recovering from its prolonged recession; the business cycle in other rich economies is more advanced. The debt hangover that has troubled them for almost a decade has faded. Job markets are also a lot tighter than a few years ago, when deflation was a serious concern. Unemployment in America has fallen to 5%, a rate which is close to many estimates of full employment. The jobless rate in Britain is 5.2%. In Germany it is 6.3%. If the recent trend of low productivity growth in these economies continues, bottlenecks in the jobs market will emerge and higher inflation may not be far behind. For instance, if America s GDP grows by 2.3% in 2016, its recent average, and growth in output per worker also matches its recent sluggish trend, the unemployment rate would decline further, to around 4%, reckons Mr Lupton. The lower the jobless rate goes, the more likely it is that wages and eventually inflation will pick up.
As rich countries were wrestling to reduce their debts, emerging markets went on a credit binge for which the reckoning is just beginning. Debt in China in particular has risen sharply relative to GDP since 2008. Some of the resulting stimulus went into factories, leading to overcapacity and falling global prices for various goods, from steel to solar panels. But a lot of China s debt went on financing housing and infrastructure, rather than its export capacity. Moreover, the Chinese authorities desire to avoid big lurches downwards in the yuan ought to minimise the risk that it exports lowflation to the rest of the world.
Nonetheless, the expectations projected by bond markets that lowflation will persist have sound underpinnings. For a start, the price of oil and other commodities does not yet seem to have reached bottom. The price of a barrel of oil fell to an 11-year low of under $36 before Christmas, before rallying a little on hopes of renewed stimulus in China. Saudi Arabia is pumping at close to capacity, in an effort to force out high-cost producers such as America s shale-oil firms and thus grab a bigger slice of the global market. The strategy has had some success. For instance, the number of oil-rigs operating in America has fallen from around 1,500 a year ago to just 538, according to Baker Hughes, an oil-services firm. But oil production in America remains above 9m barrels a day, and Iran s exports are likely to increase in 2016, thanks to the lifting of Western sanctions. For the time being, the oil market heavily favours buyers over sellers.
Where inflation can be found in the world, it is not obviously a function of capacity constraints. The biggish economies in which core inflation is above the central bank s target tend to be commodity exporters that have suffered big falls in their currencies. That, in turn, has stoked domestic inflation. Core inflation is typically well below target in countries that are importers of raw materials. And despite tighter labour markets in rich countries, wages are not rising very fast. That might in part be because of low expectations of inflation.
It seems likely, also, that the debt burden in emerging markets, and the slower growth that usually comes after a credit binge, will bear down on global prices for a while. Even if China s spare capacity is not fully exportable, plenty of other emerging markets have built mines and factories in expectation of higher Chinese growth that will now prove redundant. As nervous investors creep back to the comparative safety of developed markets, the upward pressure on big currencies, notably the dollar, will increase adding to downward pressure on local prices.
As was the case in the late 1990s, rich-world policymakers will find that they have to keep their domestic economies primed with low interest rates to offset disinflation from abroad. The strong dollar has already caused a split in American industry between strong services and weaker manufacturing. Lopsided economies may prove as hard for policymakers to steer as deleveraging ones.