Could this be the end of a deflationary era?
China, the world’s second largest economy, climbed out of producer price deflation for the first time since January 2012 in September, with factory gate prices hitting 0.1 per cent compared to the same month last year.
The unexpected reading – analysts had forecast a 0.3 per cent decline – marks tentative hope that China is no longer exporting deflation into a lowflationary world economy. China’s headline consumer inflation also rose for the first time in four months, year on year, to hit a three-month high of 1.9 per cent last month from August’s 1.3 per cent.
September’s surprise figures comes amid expectations of rising global inflation – particularly in the advanced world – as commodity prices rise and last year’s sharp energy price falls fade out of inflation baskets.
The return to producer price inflation “should serve to allay concerns about China exporting deflation to the rest of the world, as well as the rise in CPI putting any notion that the [Chinese central bank] might consider cutting rates to boost the economy firmly out of the window”, says Marc Ostwald at ADM Investor Service.
Long maturity bond yields in the US and UK have been rising recently on higher inflation expectations. The yield on 30-year US Treasuries hit a post-Brexit vote high earlier this week to 2.5 per cent while the equivalent maturity gilts are also at their highest since late June.
Bond yields are rising again today (reflecting slipping prices), up 0.044 percentage points and 0.05 percentage points on US and UK 30-year bonds respectively. In Britain, the sharp fall in sterling has led to a jump in inflation expectations.
Higher inflation would finally help central banks meet their price stability targets and ease the burden of record amounts of global debt, which currently stands at $152tn, twice the size of the global economy.
Average global inflation hit a record low of 1.4 per cent in 2015 according to data compiled by the International Monetary, the weakest since at least 1977 (see chart below).
The fund has warned the world could be sliding into a permanent deflation trap, led lower by weak global trade, insipid demand and a still unremarkable global recovery eight years on from the financial crisis.
But does China’s great deflationary escape really mark a sea change for the global economy?
Chris Scicluna at Daiwa says the Chinese economy “remains characterised by a whole host of large-scale imbalances, which have the potential to unleash new large-scale deflationary forces as and when they unwind”.
“We certainly continue to expect underlying Chinese inflationary pressures to remain subdued,” says Mr Scicluna, who notes that still sluggish global growth and worrying slumps in productivity will prevent inflation catching fire any time soon.
Julian Evans-Pritchard at Capital Economics notes that large parts of Chinese industry remain hobbled by “persistent over-supply”, exerting further downward pressure on inflation in the months to come.
“Inflation is unlikely to become a major concern for [Chinese] policymakers this year, allowing them to focus on more pressing issues such as financial stability and structural reform”.
According to Bank of America Merrill Lynch, the current global recovery is the least inflationary of all time, with nominal GDP (growth plus inflation) growing just 11 per cent in the last seven years.
With many central banks running out of road to cut interest rates, the IMF has warned of the diminishing “effectiveness of monetary policy to tackle persistent disinflation”.
It summed up the dangers in its recent World Economic Outlook:
If repeated disinflation leads firms and households to revise down their beliefs about future prices, they may postpone spending and investment decisions, leading to a contraction in demand that would exacerbate the deflation pressures.
Eventually, “persistent” disinflation can lead to costly deflationary cycles—as we have seen in Japan–where weak demand and deflation reinforce each other, and end up increasing debt burdens and hindering economic activity and job creation.
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