Inflation ain’t behaving

Central bankers have a new inflation problem. In 2024, prices have moved more in line with their forecasts but inflation still ain’t behaving.

Following Friday’s publication of US April PCE inflation and May’s flash figures for the Eurozone, now is a good time for an inflation stock take. If you don’t look that closely, inflation trends appear broadly on track as the chart below shows.

In the US, Eurozone and UK, inflation peaked in 2022, breaking multi-decade records. That peak was higher and later in Europe, which faced a much more severe natural gas shock than the US. Following rapid falls in 2023, inflation is close but not quite down to 2 per cent, with services inflation proving to be more persistent. None of this looks very troubling because the decline in inflation appears pretty much on track, especially as central bankers warned that there would be bumps in the road of normalisation.

Japan had the opposite problem, seeking to raise inflation expectations to about 2 per cent and generate persistent price rises around that level. Again, the data appears broadly consistent with that.

It is well worth clicking on the chart so you can switch between inflation measures at the annual level and annualised figures for six months, three months and the latest month’s data.

This is where things start to look less encouraging. Over the past six months, annualised inflation is above target and trending up a little in the US and Eurozone. The May data for the Eurozone is particularly disappointing on this measure. Inflation is on target in the UK but core inflation is trending higher and services inflation is more than 5 per cent.

By contrast, in Japan, inflation is falling below target over the past six months. Again, this is not what the Bank of Japan wants to see.

None of this feels entirely comfortable.

There is a possibility that the odd period was around year end, but three-month annualised inflation is not a whole lot more encouraging for any of the big four central banks.

Let’s be clear. None of this is a disaster. The story is still consistent with a bumpy path back to inflation normalisation, but I would be lying if I did not point out that officials had expected more progress by now.

It is important to look under the bonnet in each of these economies to see if the story changes with more detailed scrutiny. So let’s take a closer look.

If you do not wish to read on, the answer still looks rather discouraging without being disastrous.

US

However you cut the US PCE inflation figures, the story is the same. Inflation is a little too high on any definition for the Federal Reserve to feel comfortable.

I have listed the latest inflation data on an annualised basis on many different definitions and time periods in a bid to extract signal rather than noise.

The answer is that inflation appears to be somewhere around 3 per cent on every measure. The Fed has the luxury of a still healthy economy to wait for interest rates to bring it down to 2 per cent, but there does seem to be a last-mile delay.

I would not go as far as to call it a serious problem. Market-based inflation measures, excluding owner-occupied rent and imputed inflation measures linked to financial services fees amid a buoyant stock market, are a little better.

But the only figure close to 2 per cent is the one-month annualised market-based core inflation figure. That is not sufficient basis to declare victory.

Eurozone

In the Eurozone, the latest trend in goods prices is more favourable than in the US, as the energy crisis continues to wane for domestically produced goods and food. But the encouraging news in goods prices, which is moderating headline inflation in the short term, is not reflected elsewhere.

Goods deflation is likely to be temporary and services prices, particularly in recent months, have not followed goods prices down. A three-month annualised services rate of inflation of 5.2 per cent, with the one-month rate at 6.5 per cent, is something the European Central Bank will need to watch closely.

There is no need to press the panic button now because the interest rate of 4 per cent will still be restrictive when it is cut to 3.75 per cent on Thursday, but the ECB will need to start to see improvements from here.

If there are further unpleasant surprises, the one interest rate cut might start to look quite lonely.

UK

Headline inflation in the UK is more encouraging than the other economies following a sharp drop in gas and electricity prices in April. If headline inflation was the only measure, the UK would look as if it had beaten inflation.

But other measures paint a more troublesome picture. In the past six months, core inflation has been higher than the previous six and remains far too high at 3.9 per cent at an annual level. Services inflation running at an annualised rate of 7.1 per cent on a three-month basis and at 9.1 per cent in the past month is the prime area for concern.

There is a battle between the benign effects of moderate headline inflation on coming wage demands and the signs of persistence in services inflation.

With an election imminent, the Bank of England will almost certainly avoid the June rate cut it had pencilled in and wait a bit longer. That is fully understandable.

By August, the BoE will want to see that the residual seasonality issues that are likely to be contained in the more recent inflation numbers wane and wage pressures fall. Then, its narrative of stabilising inflation would be back on track. Things are quite likely to be OK still, but the latest figures were definitively difficult.

Japan

The important objective for the Bank of Japan is to boost underlying inflation and embed expectations around 2 per cent. With a rapidly weakening yen this year, goods prices have risen sharply, keeping headline inflation around the 2 per cent mark.

Phasing out energy subsidies in May will further help headline inflation next month, which is already evident in the figures for Tokyo that are already published.

But elsewhere, the trends are weak. Core inflation (on the same definition as other countries, excluding food and energy) is running at levels well below the 2 per cent target in 2024, as is services inflation. The trimmed mean and median inflation measures show that the bulk of price rises are slipping below target again.

The weakness of domestically generated inflation is not encouraging for the BoJ, but again not yet a disaster. It needs to hope that higher wage increases paid by the larger companies begin to force prices and other people’s wages higher.

What I’ve been reading and watching

• Japan’s Ministry of Finance has spent a record $62bn supporting the yen, to little effect, raising pressure on the Bank of Japan to act, even in the face of economic weakness. Talk is now on pressure for Beijing to allow the renminbi to fall too, after more weakness in China

• I have been sanguine about monetary policy decoupling. If you want the opposing view read Mohamed El-Erian, who warns that Europe will discover the limits of its freedom to shift rates and Gillian Tett, who warns that currency crises should not be thought of as a thing of the past

• Listen to the Economics Show with Soumaya Keynes, interviewing Neel Kashkari, the Minneapolis Fed president. I help out a bit with a couple of questions

• Over at the Cleveland Fed, Beth Hammack has been appointed its new president. This led Alphaville to worry that PhDs are losing out to Goldman Sachs alumni in the plum central bank jobs. The key takeaway: “How much this actually matters is open to debate”

A chart that matters

Falling birth rates globally theoretically should push down neutral interest rates. If you have the prospect of a shrinking population, less investment is needed, raising desired savings relative to desired investment. But as Martin Wolf argued last week, the consequences of the world’s demographic shifts are rather more important than vague estimates of the neutral rate of interest. This was his key chart.