Should we be worried about rising inflation?

Recent Data

Chart 1 shows July inflation data (based on the year-over-year percentage change in headline CPI) for a number of countries.

Chart 1. Actual and Expected Inflation
 

Source: US Bureau of Labor Statistics, Eurostat, Statics Bureau of Japan, Bloomberg, EFG calculations. Data as end July 2020.

It is clear from the chart that inflation has increased relative to June and surprised on the upside

For the countries shown in the chart both the size of the upward move relative to June and the extent to which the outturn exceeded expectations are quite large¹. For example, Italian inflation jumped from -0.4% in June to 0.8% in July relative to a consensus expectation of -0.2% for July².  

Headline inflation normally changes slowly from one month to the next, absent any large movements in the more volatile components. When items like oil or food experience large changes that can result in a large month-on-month change in inflation but such movements are known about and therefore expected by analysts. What is unusual about July’s data is not only that inflation increased by so much relative to June but that expectations were so badly wrong.

An explanation

The data has of course been impacted by changes in behaviour associated with Covid-19 lockdowns and other related policies. Looking just at the US shows that the median CPI – as measured by the Federal Reserve Bank of Cleveland - has been much less volatile than the headline CPI, which is a weighted average of the components. This is true both on the downside and on the upside, as shown in Chart 2.

Chart 2. Headline and median measures of CPI inflation
 

Source: Bureau of Labor Statistics, Federal Reserve Bank of Cleveland. Data as end July 2020.

The Cleveland Fed uses 44 sub-categories of CPI to calculate the median. The highest and lowest inflation measures for these 44 components are shown over time in Chart 3a. Chart 3b shows the same metrics excluding the energy components.

Chart 3a. Total
 

Chart 3b. Ex energy
 

Source: Bureau of Labor Statistics, Federal Reserve Bank of Cleveland. Data as end July 2020.

Charts 3a and 3b both suggest that over the past few months US inflation has been much more profoundly impacted by deflationary forces than by inflationary forces. Charts 3a and 3b show that the minimum inflation component (red line) fell sharply from January through to May of this year before rebounding somewhat in June and July. In contrast, the maximum measure (blue line) increased gently before declining more recently, something that would ordinarily be associated with weaker inflation pressures.

Conclusions

Some commentators have argued that the Covid-19 shock has the potential to impart an upward bias to inflation because of the impact on the supply side of the economy. So it is interesting to note that several large and economically important countries have experienced a sharp rise in inflation in July over and above consensus expectations. 

Closer inspection of the US data reveals that the recent uptick in inflation is due to a partial reversal of deflationary forces for some CPI components. At the same time there is no evidence of a particular increase in inflationary pressures in any of the other components. Overall this is consistent with inflationary pressures remaining benign in the months ahead. Whilst the analysis has been performed only for the US, it is plausible that this explanation is also true for other countries.

¹July data is not yet available for Japan so the measure for Tokyo has been used instead.

²Some countries - such as Germany and Spain - have not followed this pattern. They have seen inflation both decline from June to July and miss expectations.