Global inflation is about to spike due to higher worldwide commodity prices, competitive devaluations (imported inflation) and, to a lesser extent, increasing property prices.

 

The main driver of inflation is, without doubt, higher global commodity prices that have started to rise since the beginning of the summer (+2.3% in September compared to September 2015). Oil prices, which play a key role in the calculation of inflation, rose by almost 55% since its lowest point reached last January. This increase is expected to continue in the coming months, due to declining investment in the oil sector in recent years that will eventually weight on production capacity, and the possibility of OPEC agreement regarding the level of production. The success of Saudi Arabia’s first international bond sale two weeks ago (the country raised $17.5 billion) could push the country to cooperate to reduce market flooding since it found a new (cheap) way to bring money into the system. If so, it could open the door to a sustainable oil agreement that could result in higher inflation.

In the euro area, rising oil prices will inevitably lead to an increase in HICP. We know that, historically, inflation in the Eurozone is heavily impacted by year-on-year change on oil price. If inflation would be perfectly correlated with oil price, which is obviously not the case, inflation would increase to around 2.3% next year if oil price remains at 60 USD per barrel. While it is quite safe to state it won’t make it up there, the direction of inflation is very clear. Even if oil prices fall back to 40 USD per barrel, inflation is about to pick up significantly next year.

A very positive signal regarding inflation is coming from China, where PPI has recently turned into positive territory again (+0.1% in September). If the trend continues in October (PPI data will be published on November 9th), it would mean that China is finally getting out of deflation. From being the largest worldwide exporter of deflation, China will become - almost from one day to another – an exporter of inflation, which will have key global implications regarding the dynamics of inflation.

As a result of higher commodity prices and currency devaluation, in many countries, inflation came out higher than expected in recent weeks. In New Zealand, CPI rose 0.2 percent in third quarter from a year earlier (versus 0.1% according to the consensus), which temporarily boosted NZDUSD on the market. In the UK, CPI was 1% in September from 0.6% in August due the fall in the pound which pushed up the import costs of domestic manufacturers. We believe that market concerns about inflationary pressures are quite exaggerated for the moment. It seems obvious to us the British government is pretty comfortable with a lower GBP exchange rate since it helps exports, provides support to the equity market and gives competitive advantage to local producers to the detriment of foreign producers. Lower pound should not push the Bank of England to scale back further accommodative measures. Therefore, we still think there is a decent chance of another cut in interest rates in November, which will fuel the depreciation of the GBP and increase import prices as a consequence.

Moreover, in Europe, the increase in property prices is also a factor of higher headline inflation. In Spain, property prices are still 30% below their pre-crisis level but, in core countries, prices continue to jump, sometimes quite sharply. In Germany, prices are up by 30% and in Scandinavian countries, it has skyrocketed by +57% in Norway and +70% in Sweden.

The rise in headline inflation will have a negative impact in terms of economic growth, but it will bring some relief to the economic agents (private and public) who are heavily indebted and are now facing a higher cost of capital. US long-term rates, that serves as proxy to the market, has experienced a net appreciation since last July. Over the period, US 10-year bond yield has risen by 37 basis points, US 20-year bond yield by 46 basis points and US 30-year bond yield by 38 basis points. This increase indicates that rates have reached a bottom and they are getting back to more normal levels. This is currently not a concern since, in real terms, US interest rates remain at very attractive (and low) levels.

United States: The horizon is looking slightly brighter

Within a few weeks, political risk, which was a key concern few months ago, has been considerably reduced. In Europe, Spain finally gets a new government but the PP will need to find a common ground with Ciudadanos and the PSOE to pass laws since it does not have the majority (the PP has only 137 seats on a total of 350). However, the main risk identified by the market was linked to the outcome of the US presidential election. So far, an average of national opinion polls by RealClearPolitics shows that the Democratic candidate, Hillary Clinton, is leading with 48.6% of votes versus 42.1% for Donald Trump. Also, in two of the three main swing states this year (Florida, Pennsylvania and Ohio), Hillary Clinton is clearly ahead. She gets 47.4% of votes in Florida and 47.8% of votes in Pennsylvania. She is only distanced in Ohio where she gets 46% of votes versus 46.5% for Donald Trump. The lead of the Republican candidate in this state is quite narrow and corresponds to the margin of error. In these conditions, Hillary Clinton’s victory is highly probable. However, a Democratic wave is not yet certain. The Democrats are expected to regain control of the Senate but the House of Representatives should remain in the hands of the GOP, which could lead to new fistfight over the debt ceiling by year-end.

Western Europe: It’s all about the exchange rate

In the euro area, the latest indicators confirm a real economic improvement. The Eurozone PMI for October exceeded expectations, reaching 53.7 versus 52.8 according to the consensus. Germany is expected to experience in 2016 a stronger GDP growth than the USA as a result of a very good second semester. All the German indicators (ZEW, Ifo and PMI) are significantly up.

The euro area good performance is linked to the consequences of the accommodative monetary policy implemented by the ECB. Although Mario Draghi did not give any clue regarding the evolution of monetary policy at the ECB’s last press conference, he managed to push the euro much lower against the US dollar, to a level that is commonly identified as very comfortable for the central bank. Considering the likely extension of QE beyond March 2017 and the possibility of new accommodative measures (the likelihood of further deposit rate cuts is quite low considering the last ECB’s bank lending survey), the euro area’s REER is expected to decline further in the coming months and reach levels close to its low point of 2015. Lower euro exchange rate will be probably accentuated by the continued appreciation of the Dollar Index.

APAC: The Chinese yuan remains the main risk

Despite renewed public commitment to yuan stability, China is taking advantage of the political vacuum in the United States during the election period to further devaluate its currency. CNYUSD fixing is currently set at lowest level in six years. We consider the devaluation will accelerate temporarily until the beginning of February 2017. Within the course of next year, the pair should gradually reach the level of 7.00. It seems that the Chinese authorities want to maintain a very narrow spread between CNH and CNY, as it is the case since the beginning of the year, which means more frequent FX interventions. This year, the yuan devaluation has gone quite smoothly, but the risk of massive and rapid devaluation, as it happened in August 2015, remains likely in the medium term, particularly if the country’s foreign currency reserves fall too close to the threshold set at 2800 billion USD by the IMF (In September, it was around 3166 billion USD). This would have global implications much larger than the pound devaluation. This could result in lower commodity prices, especially on the oil market, thus it would pose a significant risk for the evolution of inflation. This is, from our point of view, the main risk for the global economy.

CEE-Russia: Further devaluation of the RUB

Currency devaluation is also on the cards in Russia (with near zero global impact however). We predict that the RUB could lose up to 10% of its value against the USD in the coming next two months. As we are getting closer to the end of the year, we should remember that the RUB usually gets weaker. This can be considered as a seasonal factor, that’s why many Russians decide to buy USD at this period of the year in order to avoid a depreciation of their savings. The same phenomenon should happen this year and could be reinforced by the highly possible interest rate hike in the United States. The scale of the Fed hike will be probably quite limited (around 25 basis points) and has already been partly priced in in the market. What is at stake is to know whether the central bank will accelerate the path of normalization of interest rates in 2017, which is probable considering the global outlook of the US economy and the inflation forecast. In that case, a deeper devaluation of the RUB can be expected.

A possible agreement between the OPEC countries could also play a significant role in the evolution of the Russian currency. Indeed, the positive correlation between the Brent and the ruble is extremely strong (-0.98 from January 2014 to now). However, for the moment, the outcome of the OPEC meeting scheduled at the end of November is quite uncertain and, even in the case of an agreement, it is unlikely to see a significant and lasting increase in oil price by the end of the year. Therefore, the potential of RUB rebound is rather limited in our view.

Middle-East: Door open to further easing in Turkey

Contrary to market expectations, the Turkish central bank has maintained interest rate unchanged in October despite September inflation figures better than forecasted (CPI reached 0.18% versus 0.70% according to the consensus). The status quo is directly linked to the strengthening of the US dollar, which increases capital outflows, and Moody’s decision to cut the country’s credit rating to “junk”. However, this is only a matter of time before the central bank acts again. The weak GDP growth expected in Q3, caused by the failed coup and long public holiday that occurred in September, and lower inflation compared to previous years should trigger a new action of the central bank in November. One more moving around the corridor is possible (consisting in a new cut in the upper band) before a repo rate cut (currently sets at 7.5%).

 

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