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August 25, 2022

Feeling the inflation heat around the world

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Julius Probst
Arnaud Lieugaut
Patrick Malm
Karl-Philip Nilsson
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US inflation is full of hotspots but a cooling trend is on the horizon

There are many ways to track inflation. The following heat map is a comprehensive view of how price increases are being experienced in the US economy. The various inflation gauges, gathered from a variety of sources, include personal consumption expenditure (PCE), the consumer price index (CPI), producer prices, and their “core” siblings that exclude volatile food and energy. 

Note that the most recent months are on the left side of the map. Deep shades of red indicate the strongest statistical deviation from recent norms.

Year-on-year inflation has been extremely high for more than a year now, comfortably exceeding the Federal Reserve’s 2 percent target for core PCE. Inflation expectations, on the other hand, are mostly still below 3 percent, indicating that markets are still on board with the “inflation is transitory” story. 

One reason to be optimistic is the broad-based decline in commodity prices – reflected in that patch of cool blue emerging at the bottom left of the map. This means energy will play a smaller role pushing up CPI, and will most likely start contributing to disinflation. That would be great news for the Fed.

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US wages are inflating consumer prices

The very hot US labour market is worrying for central bankers. Our chart shows how the “pass-through effect” from wages to prices gathered pace during the pandemic, according to new research from the New York Fed. That’s in stark contrast to how muted the pass-through effect was after the financial crisis. 

The employment cost index is approaching 7 percent year-on-year growth, twice the pre-pandemic rate. That’s combining with broad-based inflationary pressures. There is no doubt that accelerating wages will feed back into prices -- as services CPI is showing.

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Realising economic potential as US capacity use hits highest since 2008

One of the Fed’s headaches is good news for workers and their bargaining power: capacity utilisation, a measure of how close an economy is to maximizing its potential. The following chart shows the Fed’s data for this economic indicator. 

Two things stand out. First, capacity utilisation has been on a long-run downward trend for decades, suggesting the US economy may have been operating below its full potential for many years. Other measures, such as the output gap, seem to confirm this interpretation. It would also explain muted inflationary pressures in recent decades. 

Second, capacity utilisation has risen to its highest point since before the financial crisis. The hot economy and tight labour market obviously explain recent wage growth.

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Europeans cannot bargain on inflation-beating wages

In the euro area, negotiated wages are falling sharply in real terms – i.e., any increase is being more than outpaced by inflation. As our chart of national data shows, that decline in real wages is more than 6 percent -- a record figure across all eurozone economies, where most nations are seeing inflation approach 10 percent. 

This painful headwind for workers is reflected in abysmal consumer confidence numbers all over Europe. Given this wage erosion, it’s only a matter of time until domestic consumption takes a large hit and plunges the eurozone into an economic contraction. 

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King dollar spells trouble for global economy

The US dollar tends to appreciate in recessions, and its current strength is therefore a bearish indicator for the global economy. It’s a safe-haven currency, so investors flow in during economic downturns – and even more so when the global financial system is under stress. 

The following chart shows the greenback’s 7 percent surge this year vis-à-vis the basket of currencies known as the dollar index, as compiled by the Fed. The year-to-date gain in 2022 – the thick, black line – is graphed against the dollar’s performance for every year in recent decades. 

Two vintages stand out at the top of the graph, showing the effect of economic turmoil: 2008, year of the global financial crisis, and 1997, the year of Asia’s crisis.  

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More emerging markets are in a vulnerable place

Emerging markets usually suffer during periods of dollar strength, and this cycle is no different. More and more countries’ government bonds are yielding 10 percent or more – as shown by our chart, which tracks the number of nations suffering such a burden (as assessed by two measures of local yields that are closely watched by financial markets). 

Higher nominal interest rates are a function of rising domestic inflation. Surging yields are both a sign and a cause of macroeconomic vulnerability, as they increase funding pressures for emerging markets.

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Japanese import prices soar

Even Japan, once the poster child for a deflationary economy, is experiencing inflationary pressures. This is mostly due to rising import prices as a result of the depreciating yen. 

Japan is one of the world’s biggest commodity importers, tapping the global market to buy almost all of its coal, oil and gas. These hydrocarbons make up a significant chunk of the national energy mix. 

The following chart shows how the global commodity price shock means Japan is importing inflation. It graphs the year-on-year percentage change in what the nation pays for its energy in yen terms. As commodity prices retreat from recent highs, Japan’s price pressures should slowly subside.

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A not-so-scattered picture for global inflation

In the middle of the pandemic, a broad, global view suggested inflation was not a worry. Some nations were even seeing declining prices. That’s not true today, as our chart shows. 

The following scatterplot includes a group of large, advanced economies and emerging markets. Each nation’s position is based on its most recently reported inflation rate (July) versus its counterpart in January 2021. (The line reflects positions where inflation would be unchanged during that time frame.) 

The only two economies enjoying lower inflation than 18 months earlier are Hong Kong and Saudi Arabia. (Not coincidentally, both have currencies tied to the surging US dollar.) Every other country in the plot has seen inflation quicken.

Though widely varying local conditions affect its severity – differences in labour-market tightness, sensitivity to imported commodities, etc. – surging inflation remains a global phenomenon that is affecting almost everyone. 

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Hong Kong tourism is finally showing signs of life

The following chart shows that people are visiting Hong Kong again after quarantine policies began to be relaxed at the beginning of the year. 

Month-on-month growth has been strong, but the absolute level remains a tiny fraction of what it once was: 50,000 people visited in July, compared to the usual 5- million-plus monthly visitors that Hong Kongers welcomed in 2018.

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