The global factors that will stop inflation running riot

For most developed market economies, growth expectations lie below 25-year historical averages. Still, it is expected that several will grow more strongly than during the past 10 years, a period marked by the ‘Great Recession’ and a sluggish recovery. Meanwhile, investors continue to lower their sights on the emerging market economies.

In the coming 10 years, developed market growth is expected to run at roughly a 1.75 per cent average annualised pace, with the US at the top end of the scale and Japan bringing up the rear. In most developed economies, each year results in a trimming of expectations for labour force growth as populations age.

Slow-moving demographic factors generally do not pose much forecast uncertainty. By contrast, considerably greater mystery surrounds productivity. Projections generally assume that productivity growth will accelerate in most developed market economies relative to very weak recent trends, while remaining below long-term averages.

Since the initial stage of the current expansion, productivity growth has run at an exceptionally slow clip. This is probably down to many factors, including a drop-off in technology investment by the corporate sector and the near-completion of globalisation. While some of these explanations appear structural, other forces may prove more cyclical. Indeed, productivity growth in developed market economies has tended to revert to longer-term norms after fast or slow periods. Two-sided risk thus surrounds expectations.

Long-term emerging market forecasts have moved down in recent years. Expectations are of annual growth to run slightly below 5 per cent, with India leading the way and Russia bringing up the rear. With globalisation largely complete, emerging market economies coming to the end of an extensive credit cycle, low commodity prices, and developed market growth below historical norms, the backdrop does not look supportive.

Growth desynchronisation is expected to characterise the next several years. Emerging market economies are likely to enter a deleveraging cycle, while developed market economies have mostly passed through that phase, so credit dynamics will differ sharply. In developed markets, considerable policy divergence is expected as the US Federal Reserve begins to raise interest rates while other central banks are still easing.

Political or societal pressure for higher inflation could mount in developed markets. Many governments are carrying fairly heavy debt burdens, and faster nominal GDP growth would help reduce indebtedness. Some analysts have suggested raising developed market inflation targets as an indirect way of stimulating demand.

Alternatively, policies designed to raise the share of national income that goes to households at the expense of corporate profits could gain favour. Such efforts would likely boost unit labour costs, raising inflation rates. On the other hand, although the Japanese descent into deflation remains poorly understood, developed market economies in general will be following in Japan’s footsteps in some ways, especially in terms of ageing societies. If this phenomenon played some role in lowering Japanese inflation, it may operate similarly elsewhere.

In emerging markets, there is generally expected some overshoot of official inflation targets. Still, it is expected there will be gradual further progress in the remaining relatively high-inflation emerging economies – Brazil, India, Turkey and Russia – with broadly sideways movement in the remaining countries.

Inflation expectations in emerging economies appear less stable and more susceptible to influence from currency depreciation, commodity price fluctuations and other factors. Moreover, some emerging market central banks enjoy less independence, at least formally, than their developed market counterparts.

A return to the very high-inflation past is not currently foreseen. In spite of disappointing growth and occasional political stress, very few emerging market governments have shown any sign of abandoning the broadly sustainable policies adopted in recent decades.

Michael Hood is global strategist, multi asset solutions at JP Morgan Asset Management

EXPERT VIEW

Giordano Lombardo, chief executive and group chief investment officer at Pioneer Investments, says: “Economies across the world, both in developed and emerging markets, are experiencing deep structural changes. While we expect growth and inflation to remain low, the global economy can avoid widespread stagnation as long as major economies continue to progress on structural reforms - which we view as the most likely scenario.”

KEY FIGURES

1.5%

UK annual inflation forecast for 2016

1%

US annual inflation forecast for 2016

0.7%

Japan annual inflation forecast for 2016

2.5%

China annual inflation forecast for 2016

Source: OECD