18-07-2012
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Insight
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Lukas Daalder
The Q3 2012 Robeco Inflation Monitor shows that with the global economy slowing, there’s little need to be worried about inflation at the moment. Lukas Daalder runs the numbers.
The Q3 2012 Robeco Inflation Monitor indicates that the global outlook for inflation is decidedly muted. “Inflation fears are abating as the world economy slows,” observes Lukas Daalder, Senior Portfolio Manager at Robeco and the architect of the Inflation Monitor (click here to access the full Q3 2012 Robeco Inflation Monitor.)
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. And that, the Q3 Inflation Monitor is telling us, is just about where inflation is in emerging markets. In the eurozone and the US, meanwhile, inflation pressures are falling and are below the ten-year averages.
Eurozone indicator has fallen into negative territory
Let’s look more closely at what’s happening in the individual regions. In the eurozone, the z-score has fallen in to negative territory, with a Q3 reading of -0.27. “The Monitor is pointing lower, indicating that the threat of inflation is subdued,” says Daalder (see chart 1).
The negative Q3 z-score compares with a Q2 reading of 0.09. Back in April, Daalder forecast a further easing of inflation, based on the European economy’s loss of momentum and the dropping out from the year-on-year comparisons of 2011's peak months of March and April (click here to access Lukas discussing the Q2 2012 Inflation Monitor).
Chart 1: Eurozone inflation overview
Source: Robeco
And this easing of pressure has occurred. Eurozone inflation, which came in at 2.4% in June, has gradually declined in recent months, though it is still above the medium-term target of the ECB (below, but close to, 2.0%). Even so, core inflation has trended slowly upwards. “Inflationary pressures appear to be easing, though, as the eurozone debt crisis and austerity measures are hurting the economy,” explains Daalder.
Two inflation risks in the eurozone
That said, he notes that there are two inflationary risks in the region. First, national VAT increases may push up inflation, as governments search for measures to bring their deficits under control.
Second, the decline of the euro could also have inflationary implications. “This is reflected in commodities being the only one of the four sub-indicators to have a positive reading in the region, despite the general decline in commodity prices,” he says.
But these are not severe threats by any means. And the ECB’s decision to lower interest rates below 1% indicates that economic worries outweigh the inflationary threats in the near term. “Inflationary expectations have declined significantly in recent months,” says Daalder.
Risk of inflation in the US is subdued
The US Monitor has also declined into negative territory. The Q3 z-score is -0.21, down from a 0.19 reading in April. “The Monitor’s slightly negative reading shows that the risk of inflation in the US is subdued,” says Daalder.
Although core inflation in the US has been more or less stable for six months now (2.3% in May), headline inflation there has dropped significantly over the last three months (from 2.9% to 1.9%).
This decline has largely been driven by the fall in energy costs related to the recent slump in oil prices. “Looking at commodities as a whole, measured in dollars, price pressures are clearly in decline,” he notes.
Meanwhile, momentum in the US economy has slowed. Even though it has outperformed Europe this year, recent data from the US has disappointed, highlighting that the country is not immune to the global economic slowdown.
“On the back of the weaker data and the falling commodity prices, inflation expectations have declined, and pose no threat moving forward,” concludes Daalder.
Inflation in emerging markets has continued to decline
The Q3 z-score in emerging markets is 0.04. That is actually slightly up from the z-score of zero recorded in April, though too much shouldn’t be read into such a small move. “Inflationary pressures remain subdued, to say the least,” observes Daalder. “Economic data has been weak across the board, with emerging markets being hit by the deterioration in global growth.”
Inflation in emerging markets has continued to decline in recent months and is currently below the ten-year average in three of the four BRIC countries. India is the exception.
This slowdown has been the key driver behind the drop in commodity prices, which has led to a further decline in inflation pressures. Monetary authorities in emerging markets have reacted by cutting interest rates, with China taking the lead, making two rates cuts within a month. “It is still too early to call monetary policy accommodative,” says Daalder.
On balance, the risks for inflation in emerging markets are more or less balanced. “Even so, a further decline in year-on-year inflation rates cannot be ruled out,” he concludes.
