Ignore 12-month inflation, look at recent numbers

  • Inflation numbers are coming in above expectations and inflation concerns are rising
  • But 12-month numbers are not that important, what matters is more recent data
  • Central banks remain sanguine about inflation, meaning they are likely to react late

Inflation in the major world economies continues to edge up. Recent data have broadly speaking (though not everywhere) been somewhat higher than the consensus view. Although this uptick in inflation was to be expected, it has caused a stir among both households and businesses , and hence in the news as well. Headlines from Axios are typical: “Inflation fears go mainstream” (25thMarch 2021) and “87% of Americans are worried about inflation” (23rd April 2021), as is the one from The Times on 27th April, “Back to normal, but it’s going to cost you”.

I have repeatedly warned about higher inflation after the end of the pandemic. Nevertheless, it is important to keep in mind that the current headline inflation numbers are really not particularly relevant. This may sound strange, but it is nevertheless true. How can this be? On 2nd June last year, I published a Comment, saying, among other things, that ”the inflation numbers we are currently seeing and will see for some months, are completely meaningless.” That was true then, when the world was in the midst of the first wave of the pandemic; and it is therefore, equally true now. That is to say, the twelve-month data we now see and will continue to see for some months, are distorted by what happened a year earlier.

A year ago inflation numbers were irrelevant because neither households, nor businesses were spending. If you do not or cannot buy goods and services, their prices do not matter. Moreover, from the late spring of 2020, consumer prices fell month on month in the largest economies. Specifically, the US core PCE deflator, the Fed’s key target, either fell or was unchanged in four of the nine months from March to November; the headline CPI fell for three straight months, from March to May. In the UK, the headline CPI fell or was flat for six months in the March to November period; while in the euro area, the same held true for five months. (The period is arbitrarily chosen because it brackets the weakness of US inflation.) Therefore, twelve-month inflation data for the same period in 2021 will be artificially inflated by last year’s weakness. What really matters in terms of future inflation is therefore the 12-month numbers we will see in the late autumn and onwards into early 2022.

However, this doesn’t mean that all current inflation data is irrelevant. The monthly changes, which give us a better feeling of what is happening at the moment, remain important. Of course, these numbers are also prone to substantial fluctuations, so a better use is perhaps three-month annualised data (six-month annualised tends to be smoother but will still show the impact of last autumn and winter).

The picture is somewhat varied. However, US three-month annualised CPI has gone from 2.7% in January to 5% in March; the core PCE deflator was 0.8% in November but 3.8% in February (data lags the CPI by one month). Meanwhile, the headline PPI reached a three-month annualised rate of 11.9% in March, with the core rate at 8.3% in both cases the highest since the current series (PPI Final Demand) began in 2009. This fits in with survey data which shows both US business and households expecting higher prices in the future and with inflation expectations (whatever use they are) rising.

EA data is less strong, but the headline inflation rate has been above 5% on a three-month annualised basis since January; the core rate spiked at 4.8% in January but has since fallen back to 2.4%. Both these numbers are by historic standards on the high side, in the case of the headline rate at a 13-year high, in the case of the core rate the highest in 20 years. To repeat, these are still volatile numbers and European activity weakness means they could well come down somewhat. However, here too, the PPI is higher, a three-month annualised rate of 13.1% in February; and EA survey data shows businesses (more so than consumers) expecting higher prices – selling and buying – in coming months. 

The outliers among major economies are the UK, China and Japan. Although the UK is further along in the pandemic, and hence economic, cycle than the EA, inflation is more subdued. That being said, the headline CPI reached a three-month annualised rate of 2.2% in March, the highest since mid-2019.

As for China, its inflation data remains notoriously unreliable. Although monthly and annual data are reported, the National Bureau of Statistics does not produce an index. Suffice it to say, therefore, that there seems to be little sign of any pick-up in inflation.

Japanese consumer prices also remain weak. However, a surge in January still means that the three-month annualised headline CPI reached 3.2% in March, a rate not seen since once in 2018. Moreover, corporate goods prices are rising here too.

But Japan is relevant from another perspective. This month, the Bank of Japan lowered its inflation forecast for the year from 0.5% to 0.1%. Admittedly, the Japanese government’s mishandling of the later stages of the pandemic are likely to mean a later recovery than in Europe and North America. But the Japanese monetary authorities’ sanguine view of inflation is shared by its counterparts in other large economies, including the USA and the EA. This is likely to be a combination of being convinced that any inflation spike will be brief and contained; and – as covered in previous Comments – desirable. But that also means that they are likely to hold back any reaction to it, that is to say react too late or too little or probably both.