Inflation in the Group of 20 largest economies, which account for most of the world's economic activity, fell to its lowest level in almost eight years during June, deepening a puzzle that confronts central banks as they contemplate the removal of post-crisis stimulus policies.
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The Organization for Economic Cooperation and Development Thursday said consumer prices across the G-20 were 2% higher than a year earlier. The last time inflation was lower was in October 2009, when it stood at 1.7% as the global economy was starting to emerge from the sharp downturn that followed the global financial crisis.
The contrast between then and now highlights the mystery facing central bankers in developed economies as they attempt to raise inflation to their targets, which they have persistently undershot over recent years.
According to central bankers, inflation is generated by the gap between the demand for goods and services and the economy's ability to supply them. As the economy grows and demand strengthens, that output gap should narrow and prices should rise.
Right now, however, the reverse appears to be happening. Across the G-20, economic growth firmed in the final three months of last year, and stayed at that faster pace in the first three months of this year. Growth figures for the second quarter are incomplete, but those available for the U.S., the eurozone and China don't point to a slowdown. Indeed, Capital Economics estimates that on an annualized basis, global economic growth picked up to 3.7% in the three months to June from 3.2% in the first quarter.
That is a very different situation from the one that confronted the world economy when inflation was last lower than it is now. Back in 2009, output gaps had widened sharply as demand collapsed in the wake of the financial crisis, and central banks were desperately adding to their stimulus measures to avoid a feared slide into deflation.
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The decline in inflation rates around the world this year comes as some leading central banks have begun to contemplate a withdrawal of those stimulus measures.
In a July news conference, European Central Bank President Mario Draghi said policy makers would decide in the fall on the future of their bond-buying program, which is tentatively scheduled to end in December. ECB watchers expect the program to be extended into 2018, but at a reduced scale. Most doubt the purchases will continue into 2019.
That followed the Bank of Canada's mid-July decision to raise its key interest rate for the first time in seven years, while the U.S. Federal Reserve has raised its key rate four times since the end of 2015 and may do so again. Some Fed officials have expressed concern in recent weeks about pushing ahead with interest-rate increases in light of the softening inflation data.
However, some central banks in large developing economies are moving in the opposite direction, and cutting their key interest rates in response to weaker inflation. The latest to do so was the Reserve Bank of India, which Wednesday lowered its repurchase rate by 0.25 percentage point to 6.0%, having previously cut in October 2016.
Consumer-price inflation in Asia's third-largest economy slowed in June to well below the 2% bottom of the central bank's target range.
While global economic growth appears to be picking up this year after a disappointing 2016, one ingredient for a sustained pickup in inflation is still missing: an acceleration in wages.
Central bankers in developed economies are puzzled by the sluggish pace of pay rises given continuing declines in jobless rates. But they believe that economic growth will ultimately eliminate the gap between what their economies can produce and what they are now producing, pushing up wages and prices.
Write to Paul Hannon at firstname.lastname@example.org
(END) Dow Jones Newswires
August 03, 2017 06:14 ET (10:14 GMT)