Inflation and Expectations

Andrew Smithers
London, 1st September 2017

The fall in both CPI (from 2.9% YoY to 2.6%) and RPI (from 3.7% YoY to 3.5%) in June in the UK has had the markets breathing a sigh of relief on the inflation front. As this point marks 12 months on from the Brexit vote and the subsequent slump in sterling, there's a feeling that the worst is over on the inflation front in the UK, a view that was reflected in the gilts market, with 10yr treasury yields falling from 1.3% in early July to 1.1% now.

Meanwhile in the US, CPI, which hit +2.7% YoY in February, has slowed to 1.7% following rate hikes in March and June. As for Japan, where CPI grew just 0.4% in the year to June, inflation has proved so difficult to come by that the BoJ has been forced to set a new date by which Abenomics aims to achieve 2% inflation.

As in the UK, this performance has defied expectations, which were for inflation to be higher, and as a consequence these government bond markets have also performed well, with US 10yr yields falling from 2.4% at the start of the year to 2.2% now, whilst in Japan they have gone from a "high" of 0.12% in February to 0.06% now.

The absence of inflation is all the more remarkable because of the accompanying trend in unemployment. At 4.5%, unemployment in the UK is at its lowest since 1975. At 4.3% in the US, it is at its lowest since 2001, whilst in Japan, at 2.8%, it is at its lowest since 1994. We not only appear to be in a period of inflation-free growth, but as evidenced by the low level of 10yr government bond yields, this is expected to continue. As equity markets do not suggest any issues on the economic growth front, the conclusion is that markets are forecasting this "Goldilocks" scenario to continue.

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Inflation and Expectation