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The Lost Inflation

Inflation since 2008
Inflation since 2008

SNB , ECB , FED... they all have a common goal : maintaining the price stability in their respective currency area, as measured by the consumer price index. The target inflation rate is usually set just below 2%. That has a simple rationale. A moderate inflation rate encourages the consumption behavior of citizens, because deferred consumption would otherwise be more expensive. A stronger demand from consumers pushes the investment behavior of companies and thus the economic growth engine remains running.

Since the subprime crisis in the US, and in their attempt of saving the economic system, the central banks lost the inflation target out of sight. Despite a historically low level of interest rates and massive cash injections to the economy in the form of programs of quantitative easing, the central banks failed to achieve the desired inflation target.

The main reason for the low inflation is the price decline in energy prices. The weakening of economic activity in many emerging markets, especially in China, shook the entire commodity sector. Before the outbreak of the subprime crisis the US crude oil (WTI) was trading at its peak just above 147 USD per barrel – the price today is just above 45 dollars. The decline is partly explained by increased supply due to the use of the fracking technology by the US (OPEC kept the output stable, also for reasons of market power conservation). What is worrying though is that crude oil prices also serve as an indicator of the robustness of the global economic growth. 

Although the core inflation (inflation excluding the price development of food and energy prices), is significantly higher, the probability of a rate hike by the Fed is highly dependent on the further development of the inflation rate – exactly as the Bank of England just restated. The ECB is also concerned because of low inflation and already indicated the potential of an expansion of the QE program. The SNB won’t be able to avoid further measures neither.

Inflation will rise again once the energy prices recover, which in turn depend on the further development of the global economy. At present, the world economy stands on shaky legs. The wrong measures at the wrong time can have a major impact on global economies. That is why the central banks choose the safer way – flooding the market with money and keeping their eyes closed.

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