Last updated: 12:17 / Monday, 13 May 2013
Robeco's Peter van der Welle

Inflation not a threat

Inflation not a threat

‘Inflation is hardly a hot topic at the moment’, says Peter van der Welle, strategist at Robeco. The eurozone is faced with deflationary pressures rather than anything else, and in both the US and emerging markets inflationary and deflationary pressures are more or less in balance.

Eurozone inflation continues to decline

Eurozone inflation, which amounted to 1.7% in March, has continued its gradual decline in recent months. It is now within the ECB’s medium-term target range of below but close to 2.0%. Core inflation has trended downwards to 1.3%. ‘All major components of the Inflation Monitor point to an easing of inflationary pressures’, notes Van der Welle.

So which forces are at work here? ‘Eurozone debt deleveraging and austerity, although some relaxation on the latter is notable, keep demand-pull inflation low’, explains Van der Welle. ‘Upside price pressures will remain moderate in the medium term as consumer and producer price expectations remain anchored to their historical averages’.

On the monetary side the decline in credit growth is accelerating, mainly due to declined lending to small and medium-sized enterprises. With a hampered monetary transmission mechanism, a more resilient euro after the ECB’s Outright Monetary Transactions and moderate commodity prices because of a disappointing global recovery, deflationary pressures will play a more dominant role in the near term.

Aren’t there any risks of higher inflation in the eurozone? ‘Not many, but the most likely candidate for an upward surprise in inflation is an oil price spike as a result of geopolitical tensions’, states Van der Welle.

In the US inflationary and deflationary forces are in balance

‘In the US, core inflation has been running close to the Fed’s objective of 2%, while headline inflation at 1.3% can hardly be seen as threatening from an inflation perspective’, says Van der Welle. ‘The US economy continues to recover, with rising house prices and an improving labor market. As the shale gas revolution takes momentum, commodity prices have a lower inflationary impact.’

The Fed has continued asset purchases at a rate of USD 85bn a month to sustain asset prices. However, inflation expectations remain firmly anchored. ‘The monitor has been showing a flat pattern over the last months, which does not suggest that inflationary pressures are building’, remarks Van der Welle. As unemployment is still is above its natural rate, wage pressures remain timid, except in the energy sector. A substantial improvement in the labor market outlook will cause the Fed to lower its quantitative easing, probably later this year. ‘For now, the monitor is neutral, signaling that inflationary and deflationary pressures are more or less in balance.’

In emerging markets inflation remains moderate as commodities prices decline

In emerging countries actual inflation has crept up over the past months. Consumer prices have risen slightly above the ten-year average in three of the four BRIC countries. Russia is the exception. ‘The Inflation Monitor shows that inflationary pressures remain subdued’, notes Van der Welle.

The most important contribution to inflation in China currently seems to come from monetary induced inflation, as Chinese growth still depends heavily on credit growth. China intends to restrain credit growth, but is at the same time intervening in the FX market to keep the renminbi weak.  Economic data has been weak across the board due to weak global recovery. Monetary authorities have reacted to the slow recovery by cutting interest rates and continuing monetary expansion. ‘However, also in emerging market the risks of inflation are more or less balanced as the recent decline in commodity prices eases inflationary pressures’, Van der Welle concludes.

Robeco’s Inflation Monitor is designed to show whether inflation pressures are on the rise, thus indicating whether the risk of future inflation is increasing. The monitor’s forecasts come in the form of z-scores* that indicate how current inflation-linked data—on the economy, monetary developments, commodities and inflation expectations—should be regarded in the context of the latest business cycle.

Based on the assumption that the past ten years are a reliable proxy for a normal cycle, a stable z-score of zero would indicate that price pressures are currently in line with the average over the most recent business cycle.

*Z-score = (most recent observation – ten-year average) / average standard deviation of monthly data