Reflation in the US, but not elsewhere

Even before the latest rise in oil prices, the average inflation rate in the G7 was set to rebound to over 2% early next year. In the US, Donald Trump’s planned fiscal stimulus should boost US demand at a time when the economy is already near full capacity. But we do not think this will mark the beginning of a sustained increase in inflation throughout the world. There is still a lot of spare capacity in many advanced economies and little prospect of significant fiscal stimulus outside the US. Moreover, inflation expectations generally remain low. Against that backdrop, the US Fed is set to raise interest rates significantly next year as inflation rises to 3% or more, but monetary policy elsewhere will remain loose for a long time yet. Turning to emerging economies, sluggish growth should help contain domestic inflationary pressures, while the fading impact of currency weakness in Brazil and Russia will enable central banks there to cut policy rates sharply in 2017.