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Inflation’s rapid comeback
Inflation has returned rapidly and looks likely to be more persistent than policymakers and markets had considered for a long time.
Group Research - Econs29 Apr 2022
  • The sharp spike is felt in a higher share of Advanced Economies vs Emerging Markets
  • Global commodity prices are a key inflation driver, with bigger spikes from past oil supply shocks
  • US and Europe inflation is higher than Asia due to weaker China and more stimulative policies
  • Inflation worries rachet up Fed rate hikes
  • Asia vigilant on inflation risks but lag normalisation due to growth balance
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Inflation has made a fast comeback from the subdued environment over the past couple of years. It is also proving to be more persistent and worrisome than the initial expectations of both policy makers and markets. The sharp inflation spike is most felt by Advanced Economies (AE) vs Emerging Markets (EM). AE central banks’ monetary policy rhetoric has thus switched significantly to extreme hawkishness and tightening in 2022 from peak dovishness during the pandemic.



Looking at the top 33 economies globally (13 AEs and 20 EMs based on IMF classification), ranked on Purchasing Power Parity (PPP) terms and accounting for 85% of global GDP, more than 90% of AEs within the sample are facing above-median headline inflation in early-2022 – the highest in many decades. The share of EMs experiencing high inflation has also increased in early-2022 but is less pronounced than the spike in AEs. 40% of EMs in the sample are experiencing above-median headline inflation, lower than 70% in 2008 but above the lows of 15% pre-pandemic from 2014 to 2019.

AEs’ headline inflation spiked significantly to 6.0% YoY average in Jan-Mar 2022, a rate last experienced in the 1980s. The US is outpacing the AEs and dominating headlines. US’ headline CPI hit 8.0% YoY average in the first three months of 2022, almost twice of the long-term mean of 4.0% from 1970s. Mounting price pressures are however not confined to the US, with concerns rising in some parts of Europe.

Among the G3, headline inflation momentum (3m/3m saar %) in the US and in Europe has accelerated to very high rates. Momentum has reached close to 10%, shifting rapidly from the drop during the worst of the pandemic in 2020. Japan’s momentum is comparatively lower, even though rising. Looking at Asia generally, headline inflation looks relatively subdued in early-2022, with momentum much lower than the US and Europe and is not surging.



Evaluating key global and Asia inflation drivers

Global factors play an important role in driving inflation across economies. Our analysis shows that the variation in global inflation was primarily driven by two key global factors, based on our Principal Component Analysis (PCA) of headline inflation in the top 33 global economies from the year 2000 onwards (For more details, see ASEAN-5: Evaluating key inflation drivers). They explained 51% of the variance in headline inflation in the full cross-country sample. While the two factors are statistical constructs, we can link them to economic variables, which theory suggest may drive inflation.

We found that the first global factor fitted well with the movement of global commodity prices. It had a correlation of 0.67 with world commodity prices, 0.58 with Brent, and 0.54 with world food prices.



The current environment is characterised by supply-side commodity price spike notably in oil resulting from the Russia-Ukraine geopolitical conflict. Headline inflation in AEs and EMs has heated up alongside the oil price rally in late-2021 and early-2022 from a lower starting point compared with the 1970s. The ongoing energy price shock, so far at least, is much milder than the 1970s, and has not translated to very extreme inflation. Persistent elevated commodity prices caused by a prolonged supply shock due to geopolitical conflict in Russia and Ukraine nevertheless pose upside risks and could keep world inflation hotter than pre-pandemic years.

To also decipher the relatively muted inflation in Asia, we derived a regional factor that was driving inflation in the Asia by running another PCA on the various Asian economies’ inflation after filtering out the impact of the two global factors. The regional factor appeared to be related to China’s economic activity. Intuitively, China’s slowing growth has been a drag Asia’s growth and, by extension, demand as well. Asia’s headline inflation momentum analysis shows that the regional inflation backdrop has been dampened by cooling price pressures in China.

 
Demand-boosting policies buoying AE inflation

The pick-up in price pressure in the US and Europe is not just commodities and supply driven. Core inflation momentum (that excludes volatile food and energy price dynamics) in the US and Europe has also surged to multi-year highs. Underlying pressures for Japan and Asia are comparatively subdued. Japan’s core momentum has however turned positive after the steep drop in 2021. In Asia, China is moderating, while Indonesia, India, Singapore, and Taiwan have picked up, reflecting some underlying pressures.



The sharp core inflation turnaround and surge in the US and Europe is buoyed by ultra-accommodative and demand-boosting policies to limit the economic fallout from the unprecedented health crisis. The strong policy support has aided the rapid narrowing and turnaround of the wide output gap, with labour markets tightening, as the economies look past the virus and tough lockdowns.

To tame inflation not seen in many decades amid very low real short-term interest rates (see heatmap below), AE central banks, notably the Fed, have rapidly dialled up their policy rate hike expectations to remove extremely easy pandemic-era policies. Asian central banks are also likely to be vigilant to keep inflation upside risks and expectations in check. Balancing growth priorities would however suggest a slower rate normalisation path vs the Fed, if capital flow volatility does not turn disruptive.


To read the full report, click here to Download the PDF.

Chua Han Teng, CFA

Economist
[email protected]
 

Daisy Sharma

Data Analytics
[email protected]



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