28 March 2017
Positive base effects from energy price fluctuations over the past year are causing a rise in headline inflation across a range of economies. Once these base effects pass through, will underlying inflation pressures continue to put upward pressure on CPI? With WTI crude now 10% below its late-February high, easing energy base effects will likely cause headline CPI to decline even if oil prices remain at current levels. For global reflation to continue, underlying core inflation would need to pick up from here. In this respect the outlook is mixed. In the US, we think labour market pressures will continue to feed through, pushing core inflation towards target, albeit slowly. Additionally, in the UK the sharp depreciation in sterling will be enough to push up aggregate inflation even once the base effects from energy prices wash out. However, outside the US and UK, core inflation remains well below target in most large economies and we expect this trend to continue over the medium term. In Europe, despite headline inflation slightly above target, core inflation of just 0.9% is showing no signs of near-term upward pressure. Likewise in Japan, declining service prices and inflation expectations will make it difficult for the Bank of Japan (BoJ) to reach its 2% inflation target short of an import price shock or a significant improvement in growth expectations.
With peaking headline inflation and sporadic core inflation across most of DM, will China support continued global reflation? We think it’s unlikely for two reasons. First, although some idiosyncratic factors such as production cuts are pushing up China’s PPI, prices are still mostly a factor of higher global energy prices. In this respect China is not dissimilar from most other EM economies (see Chart 1). As oil prices decline, China’s PPI will also peak. Furthermore, surging producer prices in China have very little spillover into domestic or global consumer prices. Despite spiking PPI, China’s consumer prices have barely budged and export prices are unlikely to be significantly affected. China’s consumer goods prices are more closely aligned with the consumer goods component of PPI, which despite picking up slightly, still remains low at 0.8%. Headline inflation might be higher, but underlying inflationary pressures are still sporadic at best.