Reflationistas beware as global price revival belies risks ahead
FROM goods leaving the factory floor in China’s industrial towns to petroleum at the pump in Europe and America, prices that stayed low for years are finally going up. So that’s a good sign, right?
After a period of central bankers fretting about deflation and resorting to unconventional techniques like negative rates to respond, the easy answer is “yes.” But whether faster price gains mean that the world is finally healing from the Great Recession may be revealed only by what happens next.
In the rosy case, the global economy is now being offered a tonic by resurgent pricing for key commodities such as oil and iron ore, and a buoyant US entering the presidency of Donald Trump will help drive demand, wages and investment everywhere.
In another scenario, a litany of political risks from Trump himself to the potential bungling of Britain’s exit from the European Union await the unwary, and reflation could end up crimping consumer spending while failing to propel wages and investment.
“Some of the financial market optimism is justified but political and policy risks remain, and the rise in global inflation is likely to prove short-lived,” said Janet Henry, global chief economist at HSBC Bank in London.
Evidence of a decisive shift away from the deflation danger zone presented itself loud and clear in Germany last Tuesday, when data showed December price growth jumped a full percentage point to 1.7 per cent, the biggest increase on record. That helped push the euroarea number beyond economist expectations to its fastest pace since 2013.
In China, factory-gate inflation accelerated to the highest since 2011 in November, and in the US, the world’s largest economy, the Federal Reserve’s preferred gauge of inflation was up 1.4 per cent year- on-year for October and November, making for the fastest gains since 2014. Those shifts, coupled with expectations of faster US growth and Europe’s ongoing monetary stimulus, have helped the world economy pull back from a deflationary spiral.
“It is our belief that 2016 marked the end of the global deflationary pressures that have prevailed in recent years,” Michael Shaoul, chief executive officer at Marketfield Asset Management wrote in a note to clients. It’s an outcome that central banks and governments have been craving. Inflation reduces debt burdens and can boost activity in economies with slack, which in turn boosts demand on Main Street.
In HSBC’s latest quarterly round of global forecasts, growth and inflation in each year from 2016 to 2018 are now seen higher. The bank predicts inflation in developed economies at 1.9 per cent next year, pretty much in line with many central banks’ definition of price stability.
In Japan, where the struggle against deflation has been acute, policy makers are increasingly confident the improving global picture will help.
“I expect Japan will make a big step forward to end deflation this year with a stronger confidence than before,” Bank of Japan Governor Haruhiko Kuroda said at a New Year party of Japan’s banking association in Tokyo Wednesday.
And in the US, the presidentelect’s pledge to unleash lower taxes and fiscal spending has bolstered inflation expectations to the point that the Fed is now on early alert, watching for signs that nascent price pressures are turning urgent. Many Fed officials indicated that the chances had increased for unemployment to decline significantly below the longterm natural rate of joblessness, according to the minutes from their December policy meeting.
As a result, “the committee might need to raise the federal funds rate more quickly than currently anticipated to limit the degree of undershooting and stem a potential buildup of inflationary pressures,” according to the minutes, released Wednesday in Washington. The minutes also highlighted that the policy outlook is uncertain and current conditions still merit only gradual rate increases.
To be sure, the picture is far from uniform and gains in headline inflation can be misleading.
Sceptics say merely reflects the a recovery rebound from low commodity prices – a so- called base effect – rather than a robust recovery in underlying fundamentals. That’s a disconnect that will last, said David Mann, chief Asia economist at Standard Chartered in Singapore.
“We are doubtful about it having a lasting impact,” he said. “Second-round price effects are unlikely in a sluggish global growth environment.”
Indeed, in the euro area, where unemployment still stands at close to 10 per cent, it’s hard to imagine an uptick in headline inflation translating into the kind of strong wage gains that can help create a virtuous cycle for the economy. That means that while the main price gain index could near the European Central Bank’s target of just under two per cent annually, the “core” rate, excluding energy and food, could remain stuck where it is now, at about half that.
“The structural recovery is going to last a very long time still,” said Anatoli Annenkov, an economist at Societe Generale in London. While the euro area has proven resilient to a host of threats from China’s slowdown to 2016’s Brexit vote, the true impact of the latter may not be felt for some time yet.
And not all inflation is good. In economies where prices quickly jump, consumers may keep their wallets firmly closed. Central banks will need to tread carefully as they steer monetary policy that contains rising prices without choking off fragile growth. And companies will also be forced to absorb at least some of their extra input costs.
Another possible hindrance to faster global price gains is Trump’s pledge to narrow the US trade deficit with China through punitive tariffs and other measures that risk damaging the world’s second-biggest economy and bringing a shuttering halt to the nascent inflation recovery.
“Downside risks to the inflation outlook could come from a China hard landing,” which could result in another round of weakening for world commodity prices,” said Rajiv Biswas, Asia-Pacific chief economist at IHS Markit in Singapore.
Still, for now at least, the outlook for global growth and inflation remains upbeat. In Europe, factory gauges tell a cheery story; in the US, full employment has either returned or is drawing near. Higher costs in China will eventually be passed along to trading partners in the region and the top ones, including the US and Mexico.
That leaves global policy makers buying into the reflation narrative, but with reserve. European Central Bank President Mario Draghi summarised what many of his peers are thinking when explaining December’s decision to keep asset purchases going until the end of 2017. — WPBloomberg