UBS: ‘Inflation is not dead, just sleeping’

Reuters

• Swiss bank UBS used its latest Global Economic Outlook to discuss the prospects for global inflation going forward.
• “Inflation is not dead, just sleeping,” the bank said, arguing that underlying inflation around the world is set to return.
• “20% of the countries we cover have already closed their output gaps and we see the first stirrings of wage and price pressures,” the bank said.

LONDON — The days of high global inflation aren’t completely over, they’re just taking a bit of a breather.

That’s the opinion of a team of economists from Swiss bank UBS in its latest Global Economic Outlook note, released this week.

In the years since the financial crisis, inflation worldwide — particularly in developed countries — has been stuck, struggling to get off the ground. Price growth in the USA and eurozone has even dropped into negative territory at times.

This sclerotic inflationary climate seen across the globe in recent years has led some commentators to argue that we will never truly return to the environment that previously predominated. Lots of things have been blamed — big tech firms like Amazon and Spotify, and changes in global demographics to name just two.

But UBS’s team doesn’t buy it. In their words inflation “is not dead, just sleeping.”

“20% of the countries we cover have already closed their output gaps and we see the first stirrings of wage and price pressures,” the team, which includes Arend Kapteyn, Reinhard Cluse, and Pierre Lafourcade, writes.

“The transitory weakness in core inflation in the US is an outlier: the number of countries with increasing core inflation is at its highest since 2011.”

It will be a long, slow road to inflation’s return — in the form of consumer price growth and wage inflation — but the process has already begun, UBS says.

“The process is still slow for most, but there are notable exceptions: wage growth in Central Europe has doubled over the last few quarters, and we view Japan as being on the cusp of a substantial pick-up in inflation.

UBS’s economists have fundamental concerns with the prevailing narrative about inflation in the markets — namely that the way inflation works has changed forever — saying that the previously mentioned “transitory” weakness in US core inflation has disproportionately influenced that narrative.

Here is UBS’s argument:

“We postulate that it has been disproportionately influenced by the fall in core inflation in the US this year, which is precisely the wrong lens through which to view inflation developments in other countries. The US has one of the lowest Phillips curve slopes internationally, and generally displays very little co-movement with core inflation in other countries (see also the section on factor models later in this overview).

“While it is generally true that there is still quite a bit of slack across countries, it is no longer universally so. We estimate that output gaps have already closed in eight countries in our sample (see Figure 24 below), a few of which (Japan, Hungary, Czech Republic) show unmistakable signs of price pressures.”

And here is figure 24, as mentioned above:

UBS

Returning to Japan, UBS believes that the world’s third largest economy — which has been held up in recent years as a model of low growth and low inflation — will provide a perfect analogue for inflation around the world going forward. According to UBS, it will be much, much healthier for the economy than some analysts expect.

Here’s the bank one final time:

“Barring a strong appreciation of the Yen or commodity price shocks that spill over into core inflation, current labour market conditions suggest that with unemployment headed toward 2.5% by the end of next year, core inflation should be well on its way to 1.5% by year-end.

“That, to us, will be one of the biggest stories of 2018: the country that no one believes can reflate will actually be among the first to do so and force a re-assessment of how dormant inflation truly is elsewhere once slack is eliminated. Our view is that this rethink would be healthy, but it is not necessarily urgent.”

And here’s the corresponding chart:

UBS