Daan Struyven, Goldman Sachs’ global economist, looks inflationary drivers in a global context, and concludes that while inflation is set to subside across most G10 economies in 2H22, it will likely remain structurally higher—to the tune of an average 0.5pp above the pre-pandemic level—in the years ahead:
The inflation debate this year has centered on many dichotomies: persistent vs. transitory, supply vs. demand, and global vs. local. Although these dichotomies oversimplify the discussion, they provide a helpful framework for summarizing the current state of inflation and our inflation forecasts to levels moderately above 2% by the end of 2022.
Q: How global has the surge in inflation been in 2021?
A: Fairly global, although cross-country differences are large.
The biggest surprise of 2021 has been the global nature of the inflation surge, which has been visible not only in EM economies that have a long history of these inflationary bouts, but also in most G10 economies. Core inflation in 4Q21 is on track to significantly exceed our (and most forecasters’) expectations as of a year ago in eight of the ten G10 economies, especially in the US and New Zealand. The two exceptions are Japan and Norway, where a prolonged low inflation trend and the appreciation of the Krone, respectively, have kept inflation subdued.
Inflation has also risen sharply in most of the EM world excluding Asia. The regional average for headline inflation is on track to surge this quarter to 7½% yoy in Central and Eastern Europe, and to 8¼% in Latin America, but remain soft at just 2% in EM Asia.
Q: Does the surge in goods inflation mostly reflect weak supply or strong demand?
A: Both play a major role, but the contribution from exceptionally strong US goods demand is underappreciated.
To be sure, supply bottlenecks in the semiconductor, auto, and other sectors have played a large role in price spikes in several durable goods categories. But exceptionally strong goods demand is an underappreciated driver of the surge in global goods inflation, especially in the US. Although US real goods consumption has already declined by 5% since peaking in March when households received stimulus checks, it remains 10% above trend. Across many economies, there’s been a strong cross-country relationship between real goods spending
and the rise in goods prices since the start of the pandemic.
Excess goods demand explains 90% of cross-country differences in goods inflation and 60% of the overall rise in US goods prices. Similarly, we estimate that strong goods demand has accounted for about two-thirds of the lengthening in global manufacturing delays, based on an analysis of manufacturing PMI output and supplier delivery times.
Q: Will the 2021 inflation surge prove transitory or persistent?
A: Our central scenario is that much of the 2021 inflation surge will gradually abate in late 2022. That being said, more persistent pressures are building in the US and the UK, and we ultimately expect G10 inflation to settle ½pp above the pre-pandemic level, on average.
The US core inflation overshoot is so far entirely attributable to a surge in a limited number of durable goods categories. Although inflationary pressures will likely get worse before they get better in late 2022, we still expect this surge to gradually abate as goods demand should slow while goods supply rises next year. Our GS trimmed core inflation measure—which systematically trims a weighted one-third of outlier categories—shows how concentrated the recent inflation surge has been in most large G10 economies so far. Our September
trimmed core measure is essentially on the central bank target in the US (2.06% yoy), and the UK (1.91%), but below target in the Euro Area (1.58%) and especially in Japan (0.15%).
That said, the recent acceleration in our US trimmed measure to 3.3% on a 3-month annualized basis and the broad-based US October CPI acceleration illustrate that more persistent inflationary forces are building. Tightness in labor and housing markets, wages pressures, and the underlying inflation trend will drive the timing of inflation normalization and the level at which inflation ultimately settles. Within the G10, these persistent forces should be more pronounced in the US, the UK, New Zealand, and Canada than in the Euro area, Australia, and Japan.
On the labor market side, our GS wage trackers are firmer in the US and the UK at around 4% and 4½% year-over-year, respectively, than in the Euro Area and Australia, where they have fallen below 2%. Similarly, housing supply is very tight in the US, the UK, Canada, and New Zealand. More broadly, the pre-pandemic starting point for inflation across G10 economies remains a key differentiating factor. In fact, in the Euro Area, a further uptick in inflation expectations—which have been too low—is necessary in our forecasts to sustainably approach the ECB’s target.
Taken together, we expect inflation to moderate in the second half of next year across most of the G10. We forecast that central banks’ preferred measures of core inflation in 4Q22 will be moderately above the target in the UK (2.5%), US (2.4%), Canada (2.2%), and New Zealand (2.1%), moderately below the target in Australia (2.1% vs. the 2.5% target), and significantly below the target in the Euro area (1.2%).
Beyond the next few years, we expect inflation to settle ½pp above the pre-pandemic level on average, in part because central banks such as the Fed and the ECB have tweaked their goals accordingly. These structurally higher inflation forecasts also incorporate factors that we expect to mostly persist, including housing and energy markets tightness, elevated US wage pressures, and increased long-run inflation expectations.