Kudos to everyone! Consumer prices have tumbled rapidly, and are declining in most large countries – but hardly anyone is talking deflation. That’s because prices for most items are still edging upward – declines have been largely confined to food and energy items. But worrywarts will have little down-time. There is already talk of looming inflation, and the angst is sure to rise in the next few months.
An overreaction? Unfortunately not. We’re getting very close to the period last year when the big price tumbles hit food, energy and a few other commodities. What that means is that the year-to-year declines that affected headline price indexes ever since prices first fell will soon be over. They won’t weigh down the index any more, even though price levels are still subdued. The result? Prices are likely to shoot up quickly from October to December. The big question is, by how much?
Consider Canada’s position. Year-to-year consumer prices hit red ink right on schedule in June, with a 0.3% decline. This is likely to persist for three more months. But all things being equal, growth is expected to jump to about 1% in October, 1.5% in November and just over 2% in December. That’s a pretty fast leap to the Bank of Canada’s target level, and is likely to make the headlines.
Canada won’t be alone. The same phenomenon is occurring the world over. Obviously, the specific commodities affecting Canada’s consumption basket are traded in world markets, and are affecting consumers in Japan, Western Europe, and even emerging markets – where subsidies often distort the prices consumers pay – in the same general way. As such, concerns will likely be widespread.
Key to the reaction will be the speed that prices rise. In Canada, the price weakness percolated into the headline CPI index over a 9-month period, with growth falling from 3.4% in September, 2008 to the present 0.3% decline. There was time to get used to the deceleration – but the increase will occur in just one-third of that time span, with the potential of igniting inflation fears that could end up being self-fulfilling: if expectations change to the upside, prices and wages will be set accordingly.
Are the fears rational? On balance, no. Short-term price index increases around the world will for the most part reflect movements in the same commodity prices that brought the indexes down in the first place. In Canada, the price rebound could well take CPI growth to a point that is above the Bank of Canada’s target level, but not for long. Global economic weakness – which we expect to persist through mid-2010 – will keep most prices growing at a relatively modest pace. Thus, assuming these conditions, the bounce in price growth should rapidly return to a pace that central banks can live with.
The wild card is expectations. And it wasn’t terribly long ago that fears about short supplies of oil, gas, base metals, food and even labour, sent prices on a mad upward ride. Hopefully, most will realize that that was then, and that 9 months of GDP declines have opened up a lot of spare capacity that will have to be used up before true inflation can occur. That process will take more than a few months.
The bottom line? The world sits on the threshold of another dramatic movement in prices, this time on the upside. As in the case of the deflation fears, we can all hope that the response is as rational. If so it will limit volatility and uncertainty, and keep the global economy on track for a decent rebound.