Inflation fears have gone quiet. They had been dormant for more than a decade, woke up in mid-2018 and seem to have nodded off again. This is aggravating the recession bugs. If we’re really at the late stages of the business cycle, running out of labour, constrained by a lack of access to capital and limited availability of raw resources, why isn’t this showing up all over the place in prices and at all stages of production? Is this a mini-hibernation, or are we tucking in for a long winter of price stagnation?
What are the numbers saying? In the American economy, the most visible measure is the consumer price index (CPI). On a year-to-year basis, the CPI has been relatively stable, and is now below the U.S. Federal Reserve’s target mid-point at 1.8%. Core inflation—the measure that strips out the more volatile food and energy sectors—is livelier at 2.3%, but after a recent two-month spurt retreated again in October.
Western Europe is seeing downward movement. All-items CPI across the region slid to 1.1% in October, extending a six-month slide where year-to-year growth was a much healthier 1.9%. Measures of core inflation are well-contained, and if anything, there’s concern that current market conditions may drive the numbers further south.
Central banks in both economic areas have been responding. The Fed’s rate-tightening program is definitely on hold, with the central bank easing up in interest rates three times since mid-year. Europe, initially intent on following the Americans’ tightening stance, didn’t get to its first rate hike before the price swoon, and has now reinstituted its quantitative easing program, if only mildly. The moves in both cases are intended to accommodate the recent downshift in growth, with both the Fed and the European Central Bank (ECB) insisting that this isn’t a loosening cycle, but an effort to offset the effects of the investment slowdown, itself brought on by trade uncertainty and the concurrent freeze-up in international trade activity. Clearly, the slowing of growth is of far more concern to them than the pressures in the economy. But have they completely forgotten about the latter?
From a commodity price perspective, things are pretty tame on that front. Economic pressures notwithstanding, there’s more than enough commodity supply to handle an upsurge in growth. But is an upsurge likely? According to the central bankers’ logic, if we get resolution of the major trade frictions—the U.S.-China and Brexit—then the factors holding back growth could disappear. Our own view is that this hold-back of activity is substantial, and there really would be little restraint on it if there were more trade clarity, except perhaps for a little initial reticence.
If so, we could be into a very different inflation world. A torrent of pent-up money coming into the market suddenly would hit the market at a point where there’s very little wiggle room on the labour front (just about anywhere). It would also choke the demand for capital, which, if it turned on in an instant, would bump up against capacity constraints. Capacity utilization isn’t that far from peak that there would be enough room to manoeuvre. The Fed has warned markets not to presume that this is a loosening cycle; in fact, these moves are accommodative to what may well prove to be a transitory hiccup in overall demand. At this point, the ECB and others around the world would be very relieved if that were the case.
It may seem far-fetched at this point, but remember, just 18 months ago sights were firmly trained on impending inflation. And remember, these are numbers that central banks have to peg well in advance of their occurrence: monetary policy actions take anywhere from 12 to 18 months to have an effect on the real economy. Sharp bounces in inflation numbers may occur just when today’s loosening measures are taking effect—the exact opposite of what the central banks, or anyone else for that matter, wants.
The bottom line?
When it comes to inflation, the current growth scenario is paramount. What looks like gloom at the moment could quickly turn into an economy on a tear, pulling prices with them, and central banks that are scrambling to catch up. Let’s hope there’s actually enough spare economic capacity at that point.
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