Global inflation is about to spike due to higher worldwide commodity prices, competitive devaluations (imported inflation) and, to a lesser extent, increasing property prices.
The main driver of inflation is, without doubt, higher global commodity prices that have started to rise since the beginning of the summer (+2.3% in September compared to September 2015).
Oil prices, which play a key role in the calculation of inflation, rose by almost 55% since its lowest point reached last January.
This increase is expected to continue in the coming months, due to declining investment in the oil sector in recent years that will eventually weight on production capacity, and the possibility of Opec agreement regarding the level of production.
The success of Saudi Arabia’s first international bond sale two weeks ago (the country raised $17.5bn) could push the country to cooperate to reduce market flooding since it found a new (cheap) way to bring money into the system. If so, it could open the door to a sustainable oil agreement that could result in higher inflation.
In the euro area, rising oil prices will inevitably lead to an increase in HICP. We know that, historically, inflation in the eurozone is heavily impacted by year-on-year change on oil price.
If inflation would be perfectly correlated with oil price, which is obviously not the case, inflation would increase to around 2.3% next year if oil price remains at $60 per barrel. While it is quite safe to state it won’t make it up there, the direction of inflation is very clear.
Even if oil prices fall back to $40 per barrel, inflation is about to pick up significantly next year.
A very positive signal regarding inflation is coming from China, where PPI has recently turned into positive territory again (+0.1% in September). If the trend continues in October (PPI data will be published on November 9th), it would mean that China is finally getting out of deflation. From being the largest worldwide exporter of deflation, China will become – almost from one day to another – an exporter of inflation, which will have key global implications regarding the dynamics of inflation.
As a result of higher commodity prices and currency devaluation, in many countries, inflation came out higher than expected in recent weeks. In New Zealand, CPI rose 0.2% in third quarter from a year earlier (versus 0.1% according to the consensus), which temporarily boosted NZD/USD on the market.
In the UK, CPI was 1% in September from 0.6% in August due the fall in the pound which pushed up the import costs of domestic manufacturers.
We believe that market concerns about inflationary pressures are quite exaggerated for the moment. It seems obvious to us the British government is pretty comfortable with a lower GBP exchange rate since it helps exports, provides support to the equity market and gives competitive advantage to local producers to the detriment of foreign producers. Lower pound should not push the Bank of England to scale back further accommodative measures.
Therefore, we still think there is a decent chance of another cut in interest rates in November, which will fuel the depreciation of the GBP and increase import prices as a consequence.
Moreover, in Europe, the increase in property prices is also a factor of higher headline inflation. In Spain, property prices are still 30% below their pre-crisis level but, in core countries, prices continue to jump, sometimes quite sharply. In Germany, prices are up by 30% and in Scandinavian countries, it has skyrocketed by +57% in Norway and +70% in Sweden.
The rise in headline inflation will have a negative impact in terms of economic growth, but it will bring some relief to the economic agents (private and public) who are heavily indebted and are now facing a higher cost of capital. US long-term rates, that serves as proxy to the market, has experienced a net appreciation since last July.
Over the period, US 10-year bond yield has risen by 37 basis points, US 20-year bond yield by 46 basis points and US 30-year bond yield by 38 basis points. This increase indicates that rates have reached a bottom and they are getting back to more normal levels. This is currently not a concern since, in real terms, US interest rates remain at very attractive (and low) levels.
*Christopher Dembik is head of macro analysis at Saxo Bank.
