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The coming inflation

| Posted by: Paul Donovan | Tags: Paul Donovan Weekly

  • Over the last two years, 5% of the consumer price basket fell 75%. Over the next two years, 70% of the consumer price basket should rise 4% to 6%. The past move was oil. The future move is labor costs. The coming labor inflation matches the past oil disinflation. Unless oil prices collapse, higher inflation is coming as surely as a "Game of Thrones" winter.
  • Crude oil prices reached their lows in dollar and euro terms in January 2016. It takes time for crude oil prices to hit refined oil prices, for refined oil prices to hit transport costs (among other things), and for transport costs to hit consumer prices. Consumer prices therefore lag crude oil prices. Tight labor markets in economies like the US and Germany already generate accelerating wage gains and these costs will be more evident in consumer prices.
  • Central banks are likely to tolerate some increase in inflation – real interest rates could actually fall in 2017. There are limits, however. A 2.5% personal consumption deflator would probably trigger accelerated US rate tightening, if the Fed remains independent. For the ECB, any major country reaching 3% consumer price inflation would serve as a call to act.