Inflation rising as labour market tightens
“Deflation – it’s the bugbear of policymakers with the potential to create a debt trap where the indebted are unable to repay their loans, leading to a spiral of bank losses, credit restrictions, weaker demand and falling prices. Central banks have deployed an arsenal of measures over the last few years in an attempt to quash deflationary pressure. Indeed, policy makers continue to justify low rates by the perceived slack in labour markets and low wage growth” explained James.
“The model’s shift from a falling inflation regime to a rising one is generally down to two factors – stable commodity prices and tighter labour markets. The proportion of firms reporting recruitment difficulties is as high today as it was in 2006 – at the peak of the last economic cycle. The surge in recruitment difficulties contradicts the mantra from the Federal Reserve and Bank of England that there is ample slack in the labour market because of an abundance of under-utilised part time workers” said James.
While the model expects global inflation to begin rising again, the outlook is not uniform across all countries. Euro area core inflation is expected to remain too low for comfort, keeping pressure on the European Central Bank (ECB) to stimulate the economy. In contrast, the US and UK indicators suggest a grind higher in core inflation.
“Ultimately, this means that a divergence in central bank policy is likely. We have already seen a change towards more hawkish rhetoric from the Federal Reserve and Bank of England. If our model proves correct, this change should become more pronounced over the next year, eventually resulting in a rate hike in both the US and the UK. On the other hand, despite a reassuring stabilisation of euro area core inflation, it remains dangerously low and so the ECB are likely to continue easing” ended James.