Inflation Returns
Not long ago, one of the greatest fears stalking the global economy was the threat of long-term deflation in many of the world’s most important economies. In Japan, deflationary pressures had been in place for 25 years, while a number of European countries appeared to be stuck in a deflationary trap. Even the United States teetered on the brink of deflation last year. However, a surprising new threat has emerged, that of rapidly rising rates of inflation. In emerging markets, inflationary pressures have eased somewhat, but the threat of major currency fluctuations will keep this threat in place in the coming months. More surprising, serious inflationary pressures are beginning to emerge in many of the world’s leading developed economies, including the United States. Looking ahead, inflationary pressures may yet rise further in the months ahead and could prove to be in place for a rather long time.
The most dramatic increases in inflation in recent months have been found primarily in developed economies that have experienced years of very low inflation rates. In the United States, the rate of inflation rose to 2.7% last month, the highest level in the US since 2012, and this rate would have been even higher had it not been for a very strong US dollar. In Europe, deflationary pressures have given way to rising rates of inflation in many countries, including Spain (3.0%), Belgium (3.0%) and Germany (2.2%), as a weak euro and rising energy prices have allowed inflation rates to rise to the highest level in Europe in five years. Even deflation-ravaged Japan has managed to record four consecutive months of inflation, although here it is unlikely that inflation will continue to rise as much as it has elsewhere. Meanwhile, some emerging markets such as Argentina, Turkey and Mexico are facing the threat of major inflationary pressures, while others such as China and India have seen inflationary pressures recede in recent months. Overall, inflation rates still remain largely under control, so long as their recent increases can be contained.
There are a number of reasons why inflation rates have risen suddenly in many of the world’s leading economies. First, energy prices have risen by 20% in the wake of the deal by OPEC and some non-OPEC oil producing countries to cut oil output late last year. Second, cost levels in many service industries are on the rise as demand levels increase and as labor shortages take hold in many key sectors of the economy. These labor shortages, coupled with a slightly improving global economic growth are finally beginning to raise wage levels in developed economies. In addition, producer prices have also been on the rise in many leading manufacturing economies in recent months, further adding to the upward pressure on prices. In some key economies (such as the Eurozone, Britain, Mexico and Turkey), weak currencies are adding to the inflationary pressures in those countries. Altogether, this combination of factors has led to what has been a rather sudden increase in inflation rates in most areas of the world.
In some respects, this sudden increase in inflation rates can be viewed as a positive development for the global economy. For example, the reduction of deflationary pressures in Europe and Japan is a sign of life for both of those relatively stagnant economies and may have come at just the right time to prevent Europe from following Japan down a path of long-term deflation. On the other hand, this sudden increase in inflation rates must also be seen as a cause for concern, particularly as global economic growth rates remain rather subdued. One concern is that global wage levels will not accelerate enough to match the level of inflation rate increases, thus reducing disposable income levels at a time when consumer spending is the key component of economic growth in many leading economies. Another concern is that exchange rate fluctuations could further exacerbate inflationary pressures in many countries, particularly in emerging markets that are currently experiencing political uncertainty and unrest. As a result, policymakers will be hoping that the recent rise in inflation rates will level off in the coming months, lest action need to be taken to bring rising price levels under control, action that could potential derail a global economic recovery.