Global | Inflation overshoot possible, but not yet probable

Strong CPI figures in the US have intensified the debate about the inflation outlook, especially in the context of soaring commodity prices. In recent decades, commodity surges have not been strongly associated with inflation, but some of the structural and policy-related factors behind this may be shifting, raising the risk of an inflation overshoot.

In the 1970s and 1980s, a commodity price spike such as the recent one might have pushed up core inflation toward 7%. But since the early 1990s, the statistical relationship has been insignificant.

Could the risk from commodity prices be higher this time around? A number of factors have underpinned low inflation since the 1990s. These include moderate monetary growth, better managed fiscal and monetary policy and anchored inflation expectations, globalisation, and demographics.

Meanwhile, G7 output gaps mostly remain negative, suggesting limited inflationary risk, although the US looks an exception with our forecast being for output to exceed potential by over 3% by the end of this year.

Money supply growth is also currently very rapid across the advanced economies, raising inflation risks. A particular concern is how this may interact with the reopening of economies as the coronavirus pandemic recedes.

Most survey-based measures of inflation expectations remain contained and don’t suggest a loss of policy credibility. But market-based measures are more worrying. And while central banks are currently inclined to ‘look through’ price pressures from commodities they can’t be complacent especially as large unanticipated inflation rises have been seen in past decades.