What does falling inflation mean for investors?
Introduction
The surge in inflation coming out of the pandemic and its subsequent fall has been the dominant driver of investment markets over the last two years – first depressing shares and bonds in 2022 and then enabling them to rebound. But what’s driving the fall, what are the risks and what does it mean for interest rates and investors. This note looks at the key issues.
Inflation is in retreat
Inflation appears to be falling almost as quickly as it went up. In major developed countries it peaked around 8 to 11% in 2022 and has since fallen to around 3 to 4%. It’s also fallen in emerging countries.
What’s driving the fall in inflation?
The rise in inflation got underway in 2021 and reflected a combination of massive monetary and fiscal stimulus that was pumped into economies to protect them through the pandemic lockdowns that was unleashed as spending (first on goods then services) at a time when supply chains were still disrupted. So it was a classic case of too much money (or demand) chasing too few goods and services. Its reversal since 2022 reflects the reversal of policy stimulus as pandemic support measures ended, pent up or excess savings has been run down by key spending groups, monetary policy has gone from easy to tight and supply chain pressures have eased. In particular, global money supply growth which surged in the pandemic has now collapsed.
Why is Australian inflation higher than other countries?
While there has been some angst about Australian inflation (at 4.3%yoy in November) being higher than that in the US (3.4%), Canada (3.1%), UK (3.9%) and Europe (2.9%) this mainly reflects the fact that it lagged on theway up and lagged by around 3 to 6 months at the top. The lag partly reflects the slower reopening from the pandemic in Australia and the slower pass through of higher electricity prices. So we saw inflation peak in December 2022, whereas the US, for instance, peaked in June 2022.
But just as it lagged on the way up it’s still following other countries down with roughly the same lag. In fact, with a very high 1.5% mom implied rise in the Monthly CPI Indicator to drop out from December last year, monthly CPI inflation is likely to have dropped to around 3.3 to 3.7%yoy in December last year, which is more in line with other countries.