Latest monthly price data for OECD economies are now hitting the wires, and are sure to re-kindle inflation-chatter. Economic uncertainty has led to disparate views of near-term price movements, at the risk of confusing onlookers. Is the resumption of economic growth creating inflation pressures?
A quick scan of recent consumer price indexes could prompt a hasty “yes”. Just a few releases ago, price series in many countries were showing year-to-year declines. But these series have swiftly surged to the high end of central bank target ranges. Witness the base effect: indexes weighed down by the late-2008 plunge in specific commodity prices are now a year beyond those drops. Suddenly, today’s prices are being compared with much lower, post-crash price levels. Fortunately, month-to-month core price growth is modest, so the ramp-up in the indexes has not caused undue concern.
So much for immediate concerns; are we facing a problem as the economic recovery gains steam later this year? The base effect will actually see price indexes stabilize in short order, but there is still buzz about localized price pressure in certain economies, and the boost to specific commodity prices from renewed emerging market demand. These are legitimate concerns, but in general, the economic recovery still seems far too young to generate sustained fundamental inflationary pressure.
Consider overall demand. Levels of activity are still well below late-cycle peaks in most Western economies, and much more growth will be needed to close the gap between current and potential output. Indeed, key markets are still in the process of running down pre-recession excesses. As such, global demand is still too weak an engine to pull prices ahead at an unacceptable pace.
What about the cost side? Here too, evidence supports muted price gains. First, utilization of global productive industrial capacity is well below peak, suggesting that even if firms were faced with higher input costs, they would be hard-pressed to pass them on. Second, there is an abundance of near-term labour. Unemployment rates in most industrialized economies are still close to peak levels, a situation that will keep the lid on wage growth in the coming months.
Commodity prices are a thornier issue. A weakened US dollar and demand pressures have boosted world prices for oil and base metals. But price gains are far greater than the drop in the USD. This seems odd, since oil inventories are about 10% higher than the 5-year average, and in contrast to early 2008, there is lots of capacity to increase current production if needed. In addition, official base metal inventories are increasing at a rapid pace, and in certain cases are closing in on previous highs. Demand may be on the rise, but there appears to be ample supply to keep prices contained, raising the ugly possibility of an all-too-rapid return to market-distorting speculation.
The current state of world demand strongly suggests subdued near-term price growth, and that if specific one-off commodity or tax-related price increases occur, suppressed overall activity levels should cause these anomalous increases to be absorbed in other areas of the economy.
The bottom line? The world economy faces a number of possible near-term pitfalls as it edges toward recovery. Broadly-based excess capacity should prevent runaway inflation from being one of them.