Global Inflation: Low for Longer

Global inflation trends remain quite benign. In most of the major advanced economies, headline inflation peaked in the first quarter once the positive base effects from energy price developments had faded. In the major emerging markets, inflation is also mostly in decline, with the recovery of their currencies combined with still weak domestic demand the most important drivers in countries such as Russia and Brazil. Looking ahead, we see good reason for this benign global environment of relatively low inflation to last for longer.

Limited US Inflation Response to Strong Labor Market

One of the main reasons for a benign inflation outlook is the current low responsiveness of inflation to factors that should actually influence it more strongly. According to the Phillips curve relationship, low unemployment rates are associated with rising inflation rates. With the US unemployment rate now at a 16-year low, the US economy should thus clearly be displaying at least some signs of sustainably rising and broad-based wage and price growth. However, wage growth is largely moving sideways at around 2.5 percent Year over Year. This can have two causes: either the inflation rate has for some reason become less responsive to the declining unemployment rate or the level of the unemployment rate at which wage growth begins to increase has declined. Reduced long-term inflation expectations may be one of the underlying causes for the "flatter" Phillips curve.

Yet regardless of what is causing the lack of wage pressure so far, it indicates that core inflation is unlikely to rise much in the near term. Looking farther ahead, we nevertheless expect additional labor market improvements in the US economy to cause wages to rise and inflation to gradually pick up. However, it remains difficult to determine when that process will start and how steep the rise would then be.

Eurozone Inflation Outlook Subdued

In the Eurozone, some of the major economies are still rather far from reaching pre-crisis unemployment rates. Even in Germany, where unemployment has declined to new post-reunification lows, wage growth and inflation are not showing much upside pressure. Currently, Eurozone core inflation is still quite subdued and wage growth remains anemic. If the responsiveness of wage growth to the unemployment rate remains as weak as in the USA, the Eurozone may require loose monetary policy for quite some time. While this may not prevent the ECB from tapering its asset purchases, it could well delay the arrival of higher policy rates.

Mixed but Benign Inflation Picture in Emerging Markets

The inflation picture in the key emerging markets (EMs) is slightly different. In countries such as Brazil and Russia, which are gradually emerging from prolonged recessions, inflation has been declining rapidly and should stabilize at quite low levels. Central banks in both countries are likely to continue their easing cycles. China, however, is still growing at a fairly robust pace, with core inflation gradually drifting up; still significant overcapacities suggest, however, this will be a slow process, however. Economies that recently experienced currency weakness, for instance Turkey and Mexico, have seen inflation move higher, but this will likely be temporary and fade once higher import prices have filtered through to the economy and the currencies stabilize.