Having disappeared for much of the decade, inflation could rear its head again in the near future as the global economy creeps toward full employment and central banks turn increasingly dovish, according to Pacific Investment Management Co, known as PIMCO.
Both the European Central Bank and the Federal Reserve have struggled to move the dial on inflation consistently toward their 2% targets despite loose monetary policy and falling unemployment, while the Bank of Japan has all but given up hope with a headline figure of just 0.5% in November. The OECD inflation rate — a basket of 36 member countries — was just 1.8% in November 2019, the last published data point, having slid below 2% in August 2019.
But investment manager PIMCO says the likelihood is that the conditions are now in place for inflation to increase, although they only forecast a "benign" rise.
"The important point is the risks are much more weighted to the upside than to the downside," said Joachim Fels, global economic advisor for PIMCO.
Speaking in a PIMCO webcast, Fels noted that while the consistent fall in unemployment around the world had so far done little, the level is now "really, really low" and should result in a pickup in wages "eventually."
The OECD unemployment rate was under 5.2% in October 2019, down from a peak of 8.5% in Oct. 2009 and well below the pre-crisis level of around 6%.
The unparalleled era of loose monetary policy has tested a number of key economics principles, none more so than the "Phillips curve." The model, devised by New Zealand economist William Phillips in 1958, describes an inverse relationship between inflation and unemployment. But the theory has been under strain as a consistent fall in unemployment since 2012 has failed to spark significant inflation.
In the U.S., unemployment is at 50-year lows, while core inflation in the euro area languished at just 1.3% in December 2019 despite the ECB spending much of 2019 pointing to the potential for wage growth in Germany as a cause for optimism about the bank's 2% medium-term target.
Change in policy may be a trigger
Trillions of dollars of monetary easing has failed to stimulate demand, but Fels said the trend toward greater fiscal stimulus could.
"Fiscal policy in many places around the world is becoming more expansionary, and fiscal has much more direct impact on inflation than monetary," said Fels, who highlighted the likelihood of greater government spending in the U.K. and Europe.
The Fed and ECB may also be set to change the parameters for what they consider an acceptable inflation level during their upcoming strategic reviews. While both want to raise rates from historically low levels, there are suggestions that with economic activity so weak, both central banks would be willing to let inflation exceed their targets without looking to cool price rises with interest rates.
"Central banks would be happy to see higher inflation. The Fed and ECB are reviewing monetary policy, and one likely outcome is that they will tolerate overshoots of inflation," Fels said, noting that "the bar for tightening monetary policy is much higher than the bar for easing monetary policy further so we think they have an asymmetric bias to ease."
The potential for further price shocks in oil is a further indicator that inflation may rebound. U.S. inflation jumped from 1.8% in October 2019 to 2.1% in November boosted by energy prices, which have been supported by sanctions on Venezuelan and Iranian supply.
Oil prices spiked again amid the escalation in U.S.-Iranian military action, and Fels said that further instability in the Middle East, such as a repeat of the attack on a Saudi Arabian oil installation in September 2019, could send energy prices soaring once more.