China Effect
China’s slowdown, driven in part by new Covid restrictions, will be a deflationary shock for demand across the global economy. It’s most likely to show up in commodity prices, as Chinese purchases of everything from industrial metals to agricultural products and energy get scaled back.
Bloomberg Economics calculates that a 1 percentage point slowdown in Chinese industrial production can shave as much as 5 percentage points off global oil prices. China is the world’s biggest buyer of iron ore, and it accounted for 40% of global demand for copper in 2020 and as much as 30% for nickel, zinc and tin.
Japan’s Example
Japan is the world leader in experiencing a long deflationary bust and has seen many false dawns when the hoped-for return of inflation couldn’t be sustained. It’s too early to tell if this time will prove different. Consumer prices recently hit the Bank of Japan’s 2% target, driven by surging energy prices, but limited wage gains continue to keep consumers skittish. And the BOJ remains committed to stimulating Japan’s economy on the view that the current inflation spike is transitory.
“I expect the world to swing back from historic inflation to disinflationary and deflationary pressures,” said Takahide Kiuchi, an economist at the Nomura Research Institute in Tokyo and a former BOJ board member. “Inflation will come down at the expense of monetary policy tightening and an economic slowdown. The price trend will ultimately be dictated by the potential global growth rate, which is weakening due to the pandemic and the Ukraine situation.”
Well-Anchored?
Economists at the Peterson Institute for International Economics identified a shift in long-run inflation expectations, partly due to better central-bank policy, as one reason why US prices stayed subdued for much of that period.
“The public has expected that inflation, even if buffeted in the short run by shocks, would return in the longer run to its low, normal level,” they wrote. “That expectation, in turn, has almost certainly helped stabilize actual inflation.” And they noted that even after a year of soaring prices, long-term inflation expectations aren’t much higher than they were a decade ago.
Meanwhile, bond investors have been trimming their inflation expectations in recent weeks.
Base Effect
Some of the current inflation spike has been magnified by what are known as base-year effects. Essentially, inflation was high when year-on-year price changes were measured against a time earlier in the pandemic when economies stalled and costs slumped. But soon, they’ll be measured against the current elevated level of prices instead -- so some of that effect will reverse.
Regions such as Europe that rely on imported energy may see a greater fall in inflation than others if the price of fuels like oil and gas were to quickly cool.
“Commodity prices will start retreating,” said Priyanka Kishore of Oxford Economics. “They will remain high by historical standards. But they are unlikely to keep climbing.” She expects that by mid-2023, food and energy commodity prices will drop by 10% to 15% from a year earlier, helping to bring overall inflation down.
--With assistance from Craig Stirling and Zoe Schneeweiss.
This article was provided by Bloomberg News.