On the face of it, the rise in core inflation in several advanced economies in July seems to challenge the idea that lower demand will dominate lower supply in the tug of war over consumer prices. But we continue to think that spare capacity will keep a lid on underlying price pressures this year and next, and that the main upside risks to inflation are at least a couple of years down the line.
- On the face of it, the rise in core inflation in several advanced economies in July seems to challenge the idea that lower demand will dominate lower supply in the tug of war over consumer prices. But we continue to think that spare capacity will keep a lid on underlying price pressures this year and next, and that the main upside risks to inflation are at least a couple of years down the line.
- Having fallen in the early stages of the pandemic, core inflation rose in several DMs in July. In the US, it increased from 1.2% in June to 1.6%. And in the UK and the euro-zone, it climbed from 1.4% to 1.8%, and from 0.8% to 1.2%, respectively. This seems to support the argument that massive policy stimulus and COVID-related costs are stoking inflation, despite demand for most goods still below pre-virus levels.
- However, the recent increases in core inflation appear to be mostly due to temporary factors. In the US, much of the rise reflected rebounds in the prices of goods and services in the sectors most affected by the lockdowns, such as airfares and accommodation. In contrast, there was no plunge and subsequent rebound in alternative measures of underlying inflation, including median inflation. (See Chart 2.)
- Meanwhile, the increase in core inflation in the euro-zone was almost entirely due to the rise in clothing and footwear inflation in several countries, most notably Italy. (See Chart 3.) This rise was due to a delay in the summer sales and should be fully reversed in August. The UK experience was similar, albeit less pronounced, with a rise in clothing inflation from delayed sales playing a key part in the rise the core rate.
- Accordingly, we doubt that the rise in core inflation marks the start of a sustained upward trend. After all, in countries that were unaffected by these factors, core inflation remained weak. For instance, it fell in several euro-zone countries, and held steady in Japan at 0.4%. And, in August, core consumer prices fell by their most on record in Tokyo. (See here.)
- That’s not to say that massive policy stimulus won’t have an impact on inflation further down the line. In fact, we will be discussing these risks in an upcoming Global Economics Focus. But, in the near term, sustained above-target inflation is unlikely when economies are so far away from full employment. In most DMs, we expect headline inflation to fall this year, before only rising gradually in 2021. (See Chart 4.)
Chart 1: Core Inflation Country Breakdown (%)
Chart 2: Average Inflation & Core CPI Inflation (%)
Chart 3: Italy Clothing & Footwear Inflation (%)
Chart 4: CPI Inflation Forecasts (%)
Sources: Refinitiv, ISTAT, Capital Economics
Gabriella Dickens, Assistant Economist, firstname.lastname@example.org