Underneath the bonnet of “sticky” global inflation

I will be speaking on the “Fixed Income and FX” panel at the (virtual) Global Independent Research Conference on 13th October at 12.30 (UK time). Click here for further details.

Our measures of global headline and core CPI-inflation – weighted averages of inflation in 32 major developed and Emerging Market (EM) economies which account for over 90% of world GDP – between May 2020 and August 2021 rose respectively 2.4pp and 1.3pp to 3.5% yoy (decade high) and 2.8% yoy (13-year high). Global food price has risen over 40%.

Moreover partial data suggest that global CPI-inflation rose yet further in September.

Headline and core CPI-inflation have risen more rapidly in developed economies than in EM economies, in large part because of increase in US and Eurozone but subdued inflation in China. Whereas inflation (particularly headline) in developed economies is well above its pre-pandemic averages, EM inflation is broadly in line with 2015-2019 averages.

By historical standards inflation is theoretically a greater problem in developed economies than in EM. But this would ignore the more pernicious impact on households and businesses in poorer EM economies where governments have little fiscal firepower.

From this there are five key themes which we will analyse in forthcoming FIRMS reports:

1. Relative weights, past and future, of supply-side vs demand pull-inflation.

2. Whether global elevated CPI-inflation will ultimately prove “transitory” or “sticky”.

3. Whether/at what pace central banks will further tighten monetary. Global central bank policy rate stands at 1.53%, up only 22bp since record-low 1.31% in August 2020. As was the case following 2008 Financial Crisis EM central banks have led the way.

4. The impact of tighter central bank monetary policy on domestic and global CPI-inflation and already modest economic growth.

5. The overall implications for FX and interest rate markets, both in terms of directionality and volatility.

 

Global CPI-inflation rise – Beyond base effects and the pandemic

Our measures of global headline and core CPI-inflation – weighted averages of inflation in 32 major developed and Emerging Market (EM) economies which account for over 90% of world GDP – have risen sharply since May 2020 in year-on-year terms (see Figure 1). Unfavourable base effects are only part of the story.

 

 

Global headline CPI-inflation rose about 2.4 percentage points (pp) from 1.15% yoy in May 2020 (a five-year low) to a decade-high of 3.5% yoy in August 2021 (see Figure 1). The United Nations Food and Agriculture Organisation (FAO) World Food Index rose 41% in nominal terms between May 2020 (when food inflation prices troughed at a 4-year low) and August 2021 (see Figure 2). Global core CPI-inflation, which excludes more volatile food and energy prices, rose “only” 1.3pp during that 15 month period from a multi-decade low of 1.5% yoy to a 13-year high of about 2.8% yoy in August 2021.

 

 

Data for economies which have already released September 2021 figures (and account for about a third of world GDP) suggest that global core and headline CPI-inflation rose further in September (see Figure 3). The UN FAO World Food Index rose a further 1.2% mom in September to a 10-year peak (see Figure 2).

 

 

High and rising CPI-inflation clearly not just an Emerging Market problem

Headline CPI-inflation in developed economies rose about 3.5 percentage points (pp) between May 2020 and August 2021 to 3.6% yoy, almost three times its pre-pandemic average (2015-2019) of about 1.3% yoy and above the level recorded in EM economies of about 3.3% yoy (see Figure 4). We estimate that the 5pp rise in headline CPI-inflation in the United States to 5.2% yoy accounted for over 60% of the increase in developed economies while the 2.9pp rise in headline CPI-inflation in the Eurozone to 3.0% yoy accounted for nearly a quarter (see Figure 5). Headline CPI-inflation also rose sharply in Canada (4.5pp) and Australia[1] (4.1pp) but these two economies of course have much smaller gross domestic products and thus weights in our calculations.

The picture is both more and less nuanced for core CPI-inflation. Core CPI-inflation in developed economies rose about 1.6pp between May 2020 and August 2021 to 2.6% yoy, versus a pre-pandemic average of about 1.5% yoy, but below the level recorded in EM economies of about 3.0% yoy (see Figure 4). We estimate that the 2.7pp rise in core CPI-inflation in the United States to 4.0% yoy accounted for over 75% of the increase in developed economies while the rise in core CPI-inflation in the Eurozone, United Kingdom and Australia[2] each accounted for about 7-8%.

 

 

In contrast headline CPI-inflation in EM economies rose by less than 0.6pp between May 2020 and August 2021 to about 3.3% yoy, in line with its pre-pandemic average of 3.1% yoy (see Figure 4). This modest increase in EM headline CPI-inflation was due to a fall in CPI-inflation in China (1.6pp), India (1.0pp) and Indonesia (0.6pp). All other EM economies included in our analysis recorded an increase in year-on-year headline CPI-inflation over that 15 month period, with Brazil’s and Turkey’s inflation rates rising almost 8pp to respectively 9.7% yoy and 19.3% yoy (see Figure 5).

Core CPI-inflation in EM economies rose about 0.9 pp between May 2020 and August 2021 to 3.0% yoy, bang in-line with its pre-pandemic average. The main contributors to this increase were pretty evenly spread between Brazil, China, Russia and Turkey.

By historical standards, and at least on paper, CPI-inflation is a greater problem in developed economies than in EM economies. However, this would ignore the more pernicious impact on households and businesses in poorer EM economies where governments have limited fiscal firepower (in a latest example the UK government is considering conditional bail-outs of domestic companies struggling with high gas prices). Moreover, as noted above, partial data – which so far encompass mainly EM economies – suggest that core and headline CPI-inflation in EM economies likely rose further in September.

 

 

5 keys issues confronting markets: Inflation-growth-monetary policy impact on FX & rates

There are five key interlinked themes which follow from our analysis which we will analyse in greater depth in our forthcoming FIRMS reports:

1. The relative weights, past and future, of supply-side and demand pull-inflation within global CPI-inflation. Specifically to what extent has global CPI-inflation been driven by a) the energy shock and more broadly supply-side constraints and bottlenecks, including in labour markets, versus b) a pick-up in private demand as domestic lockdowns and social distancing rules were relaxed or removed altogether and how this will evolve going forward.

2. Whether global CPI-inflation will rise further in coming months but ultimately prove “transitory” – the consensus view among most policy-makers, at least in developed economies – or whether it will remain sticky at elevated levels medium-term.

3. Whether and at what pace central banks will further tighten monetary policy by slowing asset-purchases and/or hiking policy rates. Our GDP-weighted measure of the global central bank (nominal) policy rate currently stands at 1.53%, up only 22bp since a record-low 1.31% in August 2020 (see Figure 6).

 

As was the case following 2008 Great Financial Crisis EM central banks have led the way. The GDP-weighted average EM central bank policy rate has risen about 57bp since August 2020, according to our calculations, whereas the developed central bank policy rate has been broadly unchanged. The Reserve Bank of Australia cut its policy rate 15bp in November 2020 and since the beginning of the pandemic only the Norges Bank and Reserve Bank of New Zealand have so far hiked their policy rates (by 25bp each in September and October, respectively).

 

 

4. The impact of tighter central bank monetary policy on domestic and global CPI-inflation and economic growth rates. We note that, based on global composite PMI data, global GDP growth likely slowed sharply in Q3 from about 1.0% qoq in Q2 (see Figure 7).

 

 

5. The overall implications for FX and interest rate markets, both in terms of directionality and volatility. Despite interest rate, equity and commodity markets having been very volatile in recent weeks and (US) macro data having remained fickle on the whole, global FX volatility has remained subdued and in line with its 10-year average (see Figure 8) as we already discussed in Macro data dog not wagging FX market tail (22nd September 2021) and Low global FX vol: maturity or complacency? (12th August 2021).

 

 

 

[1] Australia data for August/Q3 2021 are not yet available so the increase in headline CPI-inflation refers to the period between May 2020 and June 2021.

[2] Australia data for August/Q3 2021 are not yet available so the increase in headline CPI-inflation refers to the period between May 2020 and June 2021.