Chart of the Month
With the ECB exiting QE and starting normalizing its policy in the end of 2019, the 2-percent inflation target remains questionable in the Euro area. One striking observation emerges when we overlay the YoY change in Brent prices with the 5-year, 5-year forward inflation swap. Market pricing has been almost non-reactive to the rise in oil prices, and inflation expectations have remained steady at around 1.7 per cent over the past 18 months.
This month’s chart shows that the historically tight relationship between global inflation and commodity prices, both measured in neutral currency, has weakened over the past two years. Previous departures have not persisted for very long, with the exception of 2003-06. If the correlation is to be restored, it implies that either commodity prices will fall by 20 per cent or global inflation would needs to rise by around 100 basis points. In a climate of tight labour markets and trade protectionism, the latter resolution looks to be the more likely outcome.
This chart presents the US Dollar Real Effective Exchange Rate (REER) index overlaid with the gross national savings rate, (expressed as a share of gross national income) with a 2-year lead. In a period of loose fiscal policy, the savings rate may rise as individuals anticipate higher tax liabilities in the future (the principle of Ricardian equivalence). It may also rise due to uncertainty over inflation or political stability (the precautionary saving principle) or in periods of stronger income or higher GDP growth (a wealth effect). On the other hand, well-developed financial markets increase the attractiveness of financial asset ownership, tending to reduce the savings rate during periods of fiscal or monetary stimulus.
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