AMP Deputy Chief Economist Diana Mousina looks at the inflation outlook.
Inflation across most major economies has been slowing noticeably over recent months. While it may seem like the fight against inflation has been won by central banks, some recent indicators have ticked up again which could see inflation take financial markets by surprise and start rising again in late 2023/early 2024.
Here are four indicators that could put pressure on inflation.
1. Price surveys
Purchasing Managers’ Indices (PMIs) are a good leading indicator of global activity. After declining since mid-2022, input and output costs have stabilised in recent months and some look to be picking up again.
As you can see in the chart below, Australian price indicators have also been trending up, especially in July, although this could be a one-off spike because of the decision to lift the minimum wage in June.
NAB Survey: Price Indicators
Source: Bloomberg, AMP
The trends in these price surveys are worth watching, as they tend to lead the hard inflation data.
2. Weather events and commodity prices
Extreme weather events can disrupt food production and supply leading to volatility in food prices. While central banks usually look through spikes in prices, the events of the past few years have shown that temporary price changes can seep into numerous components of the supply chain. After large increases in food prices throughout 2021-22, food inflation is expected to slow further – see the chart below.
Global Food Prices and Consumer Inflation
Source: Macrobond, AMP
There’s a risk that El Niño weather patterns will lead to higher Australian agricultural prices over the next 3-6 months. Outside Australia, El Niño also tends to be inflationary as non-fuel commodity prices rise, fuel prices increase (coal and crude oil demand rises as there’s lower output from hydroelectric power plants) and governments may decide to restrict supply of agricultural commodities.
Beside these weather disruptions, many commodity prices have been increasing lately including gas, coal and oil, which will add to higher near-term inflation.
3. Inflation expectations
US short-term inflation expectations have come down from their 2022 highs and medium-term expectations are still well contained but have drifted higher over the past months and are around 3% – the top end of central bank’s target range. Inflation expectations need to remain anchored to keep actual inflation contained.
US University of Michigan Consumer Inflation Expectations
Source: Macrobond, AMP
4. Real wages and consumer confidence
The slowing in headline inflation has led to a rise in real wages growth (the difference between nominal wages and inflation) around the world, although it’s still negative in Australia and the Eurozone. A rise in real wages could see consumers increase spending and lead to a rise in inflation again.
The increase in real wages growth appears to have led to a rise in consumer confidence (see the chart below) in the US and Eurozone. Australian consumer confidence is still around record lows.
Global Consumer Confidence
Source: Macrobond, AMP
What this means for investors
The rate of inflation could start increasing again leading to renewed concern about further rate hikes, higher bond yields and the risk of a recession which would be negative for share markets.
While this is a risk, we still see inflation headed lower through 2023 and into 2024 due to restrictive interest rates. But it’s worth watching the leading inflation indicators for signs of movement.
In the longer term, inflation is likely to remain higher than pre-COVID levels due to:
- the reversal of globalisation towards onshoring
- bigger governments and more intervention in sectors
- an increase in government defence spending leading to bigger budgets
- a decrease in the working age population
- the impact of climate change.
There may be some offset from productivity improvements related to technology (and more specifically artificial intelligence) which could help to keep inflation down.
This article has been written by Diana Mousina, Deputy Chief Economist at AMP.
Current as at October 2023
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