06/12/2013 - 05:46

Inflation kept in check, for now

06/12/2013 - 05:46


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Inflation pressures remain weak in developed economies, contrary to expectations after a prolonged period of quantitative easing.

Inflation kept in check, for now

Since the global economy started to recover from the GFC in 2009, there have been concerns that all the money printing by central banks in the US, Europe and Japan would result in sharply higher inflation in developed countries. This has not happened.

In fact, inflation has been falling in recent years, with the US, Europe, Japan and Canada all having inflation rates of 1 per cent or less. Australia has relatively high inflation, but it’s only 2.2 per cent.

The plunge in the price of gold from a peak of $US1,900/ounce in 2011 when hyperinflation fears were at their peak to around $US1,240 now is another sign that inflation pressures are weak.

It’s quite clear those predicting hyperinflation over the last few years did not understand the link between quantitative easing and inflation.

While central banks have boosted narrow measures of money – bank reserves and cash in the system – this needs to be lent out en masse, boosting broad measures of money supply growth and credit, resulting in much stronger levels of economic activity and the elimination of excess capacity before inflation takes off. And of course this hasn’t really happened, so no hyperinflation.

The absence of inflationary pressures means the global ‘sweet spot’ of gradually improving economic growth, with low interest rates and bond yields, can continue for some time to come.

Inflation outlook

With so much spare capacity globally, short of a sudden spurt to global growth it’s hard to see currently falling inflation giving way to a rapid rise in inflation. At least not for the next year or so. That said, inflation is usually a lagging indicator of economic activity. Inflation in the developed world fell in 2009 in response to the slump in global growth that occurred in 2008, it rose in 2010 in response to the rebound in global growth at the time, and it has fallen again recently in response to slowdown in global growth since


So, following this pattern, if global growth continues to improve in the year ahead then inflation should at least stop falling.

What about Australia?

The inflation outlook is a bit more confused in Australia because of the influence of the downtrend in the $A, which is boosting import prices, and concerns that non-traded inflation has remained high. And of course Australia has not experienced the deep recessions other developed economies have, so spare capacity is much less in Australia.

But inflationary pressures are still weak in Australia.

• Headline and underlying inflation are both running in the bottom half of the RBA’s 2-3 per cent inflation range.

• Non-traded inflation is relatively high at 3.6 per cent over the year to the September quarter.

•  Wage increases are very low with wage costs growing just 2.7 per cent year on year.

What about investors?

First, the environment of low interest rates will remain in place for some time to come. This means continued low returns from cash and bank term deposits. Assets providing more attractive cash flows than term deposits include corporate debt, real estate investment trusts, various shares and unlisted non-residential property.

Second, given the absence of significant monetary tightening, a bond crash like in 1994 is unlikely.

The most likely outcome is just low returns from government bonds reflecting their relatively low yields, with 10-year bond yields around 4.3 per cent in Australia and 2.7 per cent in the US, for example.

Third, as the generally easy global and Australian monetary environment continues through next year it will help underpin further good gains in growth assets like shares.


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