Inflation has been slowly inching up in the US for months, and finally crossed the 2% threshold in September 2017. While commodities have driven part of this – oil rose by between 12 and 14% in 2017, wages were a laggard. The wage outlook is however, improving, as the output gap (the gap between real GDP and potential GDP) as a % of GDP looks to be closing, and tax reform is expected to trickle down to employee bonuses (among other uses). The low unemployment number (c. 4%) and expectation for better wages and further job growth is likely to boost the US consumer supporting consumption as well as housing. Building products companies have seen an uptick in investor interest as a direct result.
In Europe too the end seems to be nigh for extended inflation with some commentators even expecting an “inflation surprise”. This is attributed to some of the slack in the economy diminishing, and is expected to be driven by strong growth that is above trend. The output gap in Europe is expected to turn positive this year and for unemployment to fall further, as wage pressures intensify.
The counterbalance to what should be meaningful inflationary pressures, and what seems to have acted as a check are the deflationary pulses of technology, which are only being exacerbated as tech spending continues to rise. One question posed is whether we are facing a period of sustained lower inflation as 2% becomes the new 3% – as over capacity paired with increased innovation keeps a lid on inflation from a structural standpoint. Improved efficiencies and productivities could slice through traditional cost structures.
This dance between the inflationary and deflationary drivers will be critical in 2018 as we seek to read the trends and derive their import. Jittery markets may well be moved by inflation surprises – we just don’t know what it will take to trigger the next confidence rupture.