Supply-side tightening brings supply-side inflation

Peter Warburton - 25 January 2018

Balancing the well-rehearsed bewilderment over the weakness of the wage response to tightening in developed country labour markets, is an, opposite, surprised reaction to the strength and resilience of factory output prices over the past two years. In summary, the lack of wage acceleration is countered by the gains to profits and profit margins embedded in output price inflation. Over the past 3 years, goods producers have worked off a sizeable inventory overhang, itself the legacy of Chinese over-production in 2013-14. The deep discounting required to clear excessive inventories was a major depressant on traded goods prices in 2014-15.

China’s reflationary policy shift in late-2015 has reactivated its appetite for commodity and industrial inputs and has almost single-handedly jump-started the volume of world trade in manufactures. Looking across the latest crop of ISM/PMI indicators it is painfully obvious that goods inventories are tight and pricing is keen. Producers have ramped up their output schedules but have not yet alleviated the tight supply conditions. Manufacturing production growth rates have rebounded to extraordinary annual rates: 7.2 per cent in China, 4.6 per cent in Japan, 3.2 per cent in Germany and 2.8 per cent in the UK. The US has rapid growth in industrial production, but this is largely attributable to a large growth contribution from energy.

As global companies have regained control over their supply chains, they have secured a stronger grip on international pricing. Intelligent information systems enable them to avoid involuntary inventory accumulation and react quickly to changes in consumer preferences and market conditions. The transmission of labour market tightening to global inflation may be unusually weak and slow, but the transmission of producer price inflation via global supply chains is running well ahead of expectations. 

The next stage of the drama is the likely increase in the pace of capital expenditures that is required to support the recovery in industrial production.  There are hopeful signs that this is happening already in US, Japan and Germany.

Figure 1: 

Data Source: Thomson Reuters Datastream

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