Inflation higher for longer/ Global economic fragmentation/ Industrial policy arms race/ The geopolitics of luxury/ New Zealand
Inflation higher for longer
Inflation data reported over the past week shows a broadly similar picture of reducing headline inflation, but with stickiness in core inflation. Eurozone inflation to March was confirmed at 6.9% on Wednesday, down from 8.5% in February and the lowest headline reading in a year, but with core inflation increasing to 5.7%.
Thursday’s New Zealand Q1 inflation reading was 6.7%, down from 7.2% in Q4 and lower than expected, although core inflation only reduced slightly to 5.7% (from 5.8% in Q4). And in some economies, even headline inflation is proving stubborn: the UK reported an unexpectedly high reading of 10.1% on Wednesday.
The reduction in headline inflation is partly due to base month effects (energy and food prices spiked up after the Russian invasion of Ukraine in February 2022) as well as sharply lower energy prices in Europe and the easing of post-pandemic disruptions (e.g. global supply chain costs).
Inflation is being driven by the services sector, with goods inflation now reducing. And while wage growth has been relatively muted despite tight labour markets, profit growth is making a meaningful contribution to inflation (see these slides from ECB Board member Isabel Schnabel). Indeed, company profits have been increasing as a share of GDP in the US, the Eurozone, and elsewhere, as firms have expanded their margins even with higher wages and other costs.
However, there is no strong evidence of inflation expectations de-anchoring. Last week’s IMF World Economic Outlook forecasts a gradual reduction in headline and core CPI over the next few years: although inflation is not forecast to converge to the 2% target of the major central banks until 2025.
My assessment is that inflation will remain above target for a sustained period of time, perhaps in the 3-4% range. There will be constraints on interest rate increases (because of risks to the real economy as well as to financial stability) and a range of structural (‘wartime’) inflation drivers are becoming more prominent.
Global economic fragmentation
Speeches and actions from the US, Europe, and China over the past week have reinforced the path towards global economic fragmentation discussed in my last note.
On Thursday, US Treasury Secretary Janet Yellen spoke on the US/China economic relationship. The speech was constructive in tone, but pushed back on China’s confrontational posture and unfair economic competition. The US approach outlined involves a priority on national security, a commitment to friendshoring and industrial policy, as well as a willingness to impose trade and investment restrictions on China. Although she noted that full decoupling would be ‘disastrous’, the clear implication is that US supply chains are being reshaped along geopolitical lines.
The full note is available at: https://davidskilling.substack.com/p/global-briefing-inflation-higher