Chart of the Week: Inflation in the G-7 countries

In September, inflation in the euro area hit 3.4% yoy – a 13-year high. Energy prices were up 17.4% yoy. Core prices, excluding food and fuel, accelerated to 1.9% yoy. In the United States, the economist consensus expects that core CPI will jump to 4.2% yoy in September versus prior 4.0%. This is uncomfortably high. The first estimated release is scheduled for 13 October. In the G-7 countries, we estimate that average August CPI was at 2.84% versus a pre-pandemic average of 0.94% in March 2020. Even when oil prices were hovering around $100 in 2011, average inflation was lower. It reached a peak at 2.82%. In three countries (United States, Germany and Canada), CPI is higher to 4% yoy and it remains stubbornly low only in Japan. 

At Saxo Bank, our baseline is that inflation will remain higher than expected for a longer period of time. If proved right, it will seriously challenge the Federal Reserve and the European Central Bank’s views that inflation is transitory. You can always argue the duration of the « transitory » period, of course. But the sad reality is that there is growing evidence that inflation might be more permanent. It has little to do with fiscal dominance and inflation expectations, in our view. The four inflation pillars are right now : 

1)      Bottlenecks and supply chain bullwhip. This is normally cyclical. But it can become structural. Looking back, the consensus has continuously been too optimistic about the pandemic duration. It assumes consumers will switch back to services as Covid fades and that supply bottlenecks will settle down afterwards. We fear that issues related to vaccine efficacy, the risk of new variants, and sluggish vaccine rollout in many parts of the world, especially in China, could postpone the rebalancing. We could therefore face more persistent supply disruptions in the coming months, and perhaps in the coming quarters. 

2)      ‘Radical’ left policies which can create the conditions for forced wage growth. This is structural, and sticky in nature. We see this happens in the United States, for instance.

3)      ESG and green inflation – i.e. carbon tariffs. There are talks to increase the carbon tax in the EU to Є200 per ton by 2030 against Є60 currently. This is the right price to spur climate innovation and technical progress and reduce CO2 emissions. But it will have an impact on inflation. This is structural (see, The sad reality of the green transition, 5 October 2021). 

4)      The lack of investment in energy infrastructures which goes back to years ago, especially in fossil fuel energy. This can be potentially structural. Adding to that record demand and China pushing to secure gas supplies, a short-term easing in prices is unlikely. Imagine the winter is cold in Europe, some countries could experience power cuts. 

We don’t have a better track record in forecasting inflation at Saxo Bank than any other investment banks. We well understand that assessing the evolution of inflation in the near- and medium-term is almost an impossible task. But we think that the market and policymakers have been too complacent about the trajectory of inflation in recent months. They have downplayed evidence that several structural factors are pushing underlying inflation upward. To be clear, we don’t see any risk of wage-prices spirals, at least not in the eurozone, perhaps in the United States and in the United Kingdom. We believe we are entering into a new macroeconomic regime marked by volatile and higher inflation and lower economic activity than initially expected. This is not strictly speaking a stagflation. But we agree, it looks a lot alike.

Not all policymakers are in the so-called team transitory, fortunately. In the past few days, the central bank of New Zealand raised its key policy rate for the first time in seven years by 25 basis points to 0.50%. The Polish central bank caught the market by surprise with a stunning 40 basis point hike to 0.50%. Other central banks will follow. The divergence in monetary policy that is taking shape at the global level will have profound market consequences. Expect higher volatility, negative risk sentiment, flight to quality and FX carry trade could soon make a comeback, amongst other things.