Our call on global inflation | Article

The long road towards lower inflation

Generally speaking, manufacturing firms across developed markets are reporting lower orders and rapidly rising inventory levels. Coupled with lower input prices for many commodities and also shipping, this points not only to lower inflation but also potentially to outright price falls in some durable goods categories; we already see that with used cars. That’s consistent with history, too: Goods inflation, particularly consumer durables, tends to be more volatile, but trends are also less persistent than services inflation. Just as goods price inflation surprised higher during Covid, it also has the potential to do the same on the downside.

In the US, the latest ex-food and energy inflation readings are undershooting expectations, with some evidence that weakening corporate pricing power is spreading as businesses become more cautious about the outlook and see their inventory levels rise. However, Federal Reserve officials have signalled concern about services excluding housing (around 25% of the inflation basket) with the latest strong wage data set to keep them cautious.  We believe that the high share of shelter and used cars in the inflation measure (more than 40% of the basket) could push down headline inflation faster than many policymakers currently expect. After all, they reflect assets, so there is greater scope for outright price falls than for services.

In the eurozone, however, headline inflation could prove to be a bit stickier, certainly if our house view is correct and gas prices stay high into winter 2023. Also, the pass-through from higher wholesale gas prices to consumers comes in waves and is likely to continue far into next year. As a consequence, headline inflation will just gradually come down and will only reach the ECB’s 2% target in 2024.

Labour markets pose more of a conundrum but are crucial for the outlook for core inflation. While there’s little doubt hiring appetite is weakening as recession sets in – and that will continue – structural labour shortages suggest firms have an incentive to ‘hoard’ staff more than in past recessions. Given that demographics are less favourable in Europe than in the US, labour hoarding could be more accentuated in Europe. That suggests wage growth may also not slow as much. In any case, let’s not forget that wage growth is one of the most lagging indicators and even with a looming recession, wage negotiations at the start of 2023 will still be highly impacted by the inflation developments of the past two years and less by the looming recession. Remarkably, the UK faces a unique situation of an uptrend in the proportion of adults neither employed nor actively seeking a job, a situation exacerbated by healthcare problems.