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Economy in Brief

Negative Growth Surprises Ought to Calm Inflation Fears
by Andrew Cates  September 7, 2021

The world economy is now potentially entering a more difficult - and more volatile - phase. Incoming global economic data has been softening and increasingly falling short of expectations. Inflation outcomes in the meantime have been climbing, often quite sharply, and surpassing forecasters’ expectations at the same time. It almost goes without saying that this combination of negative growth surprises and positive inflation surprises is challenging for policymakers. Should Central Banks, for example, now pursue a tighter monetary policy campaign in order to mitigate inflationary pressures? Or should they stand firm and wait for weaker economic activity to run its course and – via demand channels – to nip inflation in the bud? Recent communications from the world’s central bankers suggest that most are standing firm for now. And there a number of features of the recent global dataflow that suggest they may be right to do so.

The first concerns the nature of the retreat in the incoming data. Forward looking survey indicators (e.g. the PMI and sentix surveys) have softened, admittedly from fairly high levels, but nevertheless in a broadly based fashion at both the sector- and country-specific level (see figure 1). In addition the global data surprise index from Citigroup has declined extremely sharply over recent months, in fact at its sharpest pace over the past 3-month period since January 2009 (see figure 2). That decline moreover has also been very broadly based with negative surprises engulfing most major economies, including the US and China and more recently the Euro Area. These developments have, incidentally, not yet triggered that much of an adjustment in investors’ growth expectations. Global equity market multiples, for example, still seem quite rich relative to the evolution of the economic data (see figure 3). And that may well imply that the incoming data in the weeks ahead could continue to surprise market expectations on the downside.

Figure 1: Forward looking global survey data has softened in recent months

Figure 2: Negative global economic data surprises

Figure 3: High global equity market multiples relative to global data surprise trends

The next feature of the global economic scene that ought to offer some comfort for Central Banks on the inflation front concerns commodity prices. For weaker than expected growth outcomes appear to have elicited a negative response from commodity markets (see figures 4 and 5 below). Higher commodity price pressures have of course been a key source of upward pressure for headline consumer price inflation in most major economies in recent months. Any evidence that suggests that these upward pressures are reversing should accordingly be welcome.

Figure 4: Slowing commodity price inflation in tune with negative global data surprises

Figure 5: Potential relief for US CPI inflation from slower commodity price inflation

Another feature of the global economic scene that will not have gone unnoticed among Central Banks concerns the position from which this global economic deceleration has started. Most of the economies in the G20 are still operating at levels that are below their pre-COVID peaks (see figures 6 and 7 below). It is somewhat difficult to argue, against that backdrop, that the world economy is overheating. It should, therefore, be even more difficult to argue that a tighter monetary policy campaign, in general, is appropriate in order to fend off inflationary pressures.

Figure 6: Most G20 economies are still running at levels that are below their pre-COVID peaks

Source: Haver Analytics

Figure 7: Global growth outcomes are partly contingent on how much progress has been made to recover the ground that was lost by the COVID pandemic

Source: Markit, Haver Analytics

Of course, one of the key reasons for the recent phase of global economic weakness relates to the so-called Delta variant. This can be seen in figure 8 below which shows the correlation between the latest August estimates for the composite PMI in various major economies against the 3-month change in COVID case numbers. Sharply rising case numbers in the likes of Australia, Japan and China were associated with a much weaker PMI relative to , say, Germany, Italy and France, all of which have seen fewer COVID cases.

Figure 8: The impact of the Delta variant on COVID cases is loosely connected with the relative performance of major economies in recent weeks

Source: Markit, Haver Analytics

These COVID considerations though may be important too in tracing (and mitigating) the current sources of inflation tension. For much of that tension is originating from supply side congestion as domestic and international supply chain channels are being choked by COVID-related bottlenecks. Recent surveys from the US and the Euro Area moreover suggest this supply chain congestion is increasingly – and worryingly - infecting labour markets with potential consequences for wage inflation (see figure 9).

Figure 9: Still acute evidence of supply side congestion

But while this obviously poses challenges for central bankers in meeting their inflation targets it need not again necessarily imply that tighter monetary policy is appropriate. This supply side congestion after all does not have loose monetary policy as one of its roots. And as we have argued in previous posts (see, for example, Post-Pandemic Productivity Promises) there is growing evidence to suggest that companies are adapting to these challenges by investing in productivity-enhancing technologies (see figure 10 below). If investment is stepping up and if productivity is responding monetary policy can remain looser for longer without triggering higher inflation. Proper policymaking is always a judgement call but the evidence suggests that overreacting to fears of inflation may prove to a be a miscalculation.

Figure 10: Orders for technology equipment are still climbing sharply

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

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