We have mentioned this several times within our previous articles, but today we thought it would be a good idea to look into inflation – the single most important determinant on the financial markets this year.
Inflation rates measure the increase in the prices of goods and services over time, usually in monthly and annual statistics. During the global financial crisis of 2008 inflation changed sharply, so many central banks were forced to adapt to it by implementing special policies aimed at increasing inflation to the healthy rates of 2-3%. Other than this golden mean for inflation, a strong economy would also be characterized by wage growth that matches inflation to ensure that the purchasing power of people remains the same, i.e. that goods and services are not becoming too expensive.
Since 2015 the United States became the first of the major economies to start moving away from this approach to increase inflation and instead the Federal Reserve came up with a more hawkish plan of monetary policy – gradual interest rate increases. The rate hikes keep inflation in check, making sure it does not rise too much or too fast. Recently the Bank of Japan also showed signs of switching its approach by reducing its stimulus package. However, the European Central Bank has so far been reluctant to ease the stimulus across the eurozone. Nevertheless, analysts keep a close eye on economic data which may suggest the economy is strong enough for a rate increase. Among these, the key reports are unemployment and inflation rates.
Over the past week we had a number of inflation reports from around the world.
To start with, the United States published their inflation numbers of January. At 2.1% the data looks fantastic and was better than expected, paired with low unemployment and adequate wage growth. This testifies to the health of the US economy right now and will most likely lead to an interest rate increase by the Federal Reserve in March. It was expected that the USD would receive a boost from the good news, but instead the dollar continued to decline. However, if there is a rate increase in March, that would be a glimmer of hope for those of you looking forward to a stronger dollar.
Data from Europe is still a bit inconclusive. German bond yields, despite some daily fluctuations, are still rising, which is a good sign for the European economy. Even reports from Italy and Greece, two EU countries that have had their economic struggles, have been more positive lately. German inflation data for January showed an increase, with the YoY reaching the coveted 2%. The ECB has stated that right now it expects some instability on the markets due to the changing price of oil and other fuels, and the still wintery season, but expect things to stabilize soon, with more economic growth in store. If things go their way, 2018 might really turn out to be the year when the ECB reveals a plan to reduce its stimulus measures and turn towards a more hawkish monetary policy.
On the other hand, inflation in the United Kingdom is higher than desired. It peaked at 3.1% at the end of 2017, with 3.0% for December, and analysts expected it to go below 3% in January. Instead, inflation remained stubbornly at 3%, so now an interest rate increase by the Bank of England is widely expected, in order to control the damage caused by Brexit and keep the economy at a balance.
Meanwhile, in Japan rising inflation would be considered good news. The East Asian country’s biggest problem for decades has been a stagnant, deflationary economy. The Bank of Japan is still far from its 2% inflation goal, but recent BoJ decisions have helped increase inflation at least a little. This week the yen is enjoying particular attention due to political insecurities in the United States, which traditionally push investors’ interest towards the yen.
Overall, inflation right now is moving in many different ways across countries and central banks are beginning to lead divergent policies. Our best bet right now is to wait and see how things go, but we must remember to keep an eye on inflation throughout 2018.
