Inflation's Back, But Will It Stay?

Not that long ago, deflation appeared to be a greater threat to the health of the global economy than inflation.  Then, beginning last year, there were signs that inflation could again become a major threat to many of the world’s leading economies.  Now, inflationary pressures are clearly on the rise in many countries around the world and there are concerns that, given the threats facing the global economy at the moment, inflation rates could continue to rise in many areas of the world.  So far, it has been emerging markets that have borne the brunt of these inflationary pressures, particularly those emerging markets that have experienced sharp depreciations of their currencies in recent months.  This is but one of the many factors that are causing so much hardship in emerging markets these days, with rising inflation most notable in many of the world’s more volatile economies.  At the same time, inflation is also on the rise in developed economies, rising to their highest levels in recent years.  While these inflationary pressures in developed economies have yet to reach a critical level, some of the threats currently facing the global economy could lead to even higher levels of inflation in the months ahead.

A number of factors are driving this increase in inflation rates around the world, factors that can vary country-by-country.  However, some of these factors are found in most major economies today, and are contributing to the recent rise in inflationary pressures.  Here are five of these factors:

• Exchange rates: On one hand, the US dollar has strengthened against almost all other currencies in recent months, while some emerging market currencies depreciated dramatically due to fears among investors over these countries’ economic and financial outlooks.

• Energy prices: While the price of oil and some other commodities has leveled off of late, commodity prices remain much higher than they were in recent years and this is helping to fuel inflationary pressures.

• Wages: After a long period of stagnation, wages are rising in most developed economies, and have been rising for a longer time in many of the world’s emerging markets.  Meanwhile, labor shortages are beginning to have a major impact on wage levels in many countries as working-age populations stagnate or decline.

• Demand levels: The recent run of strong economic growth and rising wages has led to an increase in consumer and business demand in many of the world’s largest economies, thus adding to the upwards pressure on prices.

• Trade barriers: The impact of the emergence of major trade barriers in many areas of the world has yet to be fully realized, but already, price levels are beginning to be pushed upwards by the expected impact of these trade barriers on production costs and other elements of inflation in the coming months.

To date, the worst of these inflationary pressures has been found in emerging markets, with some of these economies recording a sharp increase in inflation rates over the first half of this year.  Emerging markets such as Turkey, Argentina and Iran have seen their currencies weaken dramatically in recent months and this has fueled major increases in inflation rates in those countries.  Of course, the poster child for the threat of inflation remains Venezuela, where hyper-inflation has resulted in inflation rates as high as 25,000% in that country this year.  Unfortunately, many of the factors that have been contributing to this increase in the level of inflation in emerging markets are likely to remain in place in the coming months.  Thus, inflationary pressures will be one of the key threats facing the world’s emerging markets over the remainder of this year.

In developed economies, inflation rates have been trending upwards for most of the past year, and now stand at their highest levels in recent years.  In the United States, the recent spike in prices has resulted in inflation rates that are now at their highest level since early 2012, with inflation rising as a result of rising wages and higher energy prices.  In Europe, deflation was a significant threat just a couple of years ago, but now, inflation rates have risen across much of that region as energy prices have risen and as the euro and other regional currencies have weakened.  Meanwhile, other developed economies such as Canada and Australia have also recorded higher levels of inflation in recent months, a trend that is expected to continue over the near-term.

For the moment, there is still a chance to prevent inflationary pressures from becoming too big of a threat to the well-being of the global economy, as, with a few exceptions, inflation still remains under control.  However, it is clear that inflation-related risks are on the rise.  For example, the spread of trade barriers such as tariffs would have a major impact on price levels all around the world.  Likewise, labor shortages are forecast to worsen in places such as the United States, Japan, Germany and China, further raising wage levels and thus fueling more inflationary pressures.  Meanwhile, some emerging markets are likely to continue to suffer from particularly high levels of inflation, especially if capital continues to flow out of these markets and their currencies continue to weaken.  Not long ago, inflation appeared to be a thing of the past for all but the most volatile economies.  Now, inflation is emerging as yet another significant threat facing the global economy as it prepares for what could be a very volatile second half of 2018.