Will the global slowdown be reflected in lower inflation?

Headline inflation is peaking but the extent of any decline is unclear. Core rates – excluding food and energy – may continue to rise a while longer, reflecting lingering capacity pressures and the pass-through of earlier cost increases.

Why will headline inflation subside?

Mainly because of the oil effect. Oil started surging about a year ago so the annual rate of increase will start to fall sharply if prices now stabilise (first chart).

Will core inflation follow headline lower?

Core rates may continue to firm near term, particularly in emerging economies, where labour markets are tight and there is greater evidence of “second round” inflation effects. A rise in core inflation could temper relief at the fall in headline rates and block central banks from easing monetary policies.

Ultimately inflation is a monetary phenomenon – has money growth slowed in the wake of the credit crisis?

It has but not by much yet. Our global broad money measure is still rising at a 12-13% annual pace, which is above the average of recent years (second chart). This is consistent with some decline in underlying inflation in 2009-10 but possibly not by enough to satisfy central banks.

So hopes of significant monetary policy easing may be disappointed?

Policies are already quite loose. For example, G7 headline inflation is now well above a weighted average of short-term interest rates. This has disturbing echoes of the 1970s, when high inflation became entrenched (third chart). Central banks will want to restore positive real rates when credit conditions begin to normalise.

Could policies be tightened then?

US interest rates are particularly low relative to inflation and are likely to be raised if the economy recovers as I expect. However, there may be scope for modest cuts in Europe. So the most likely scenario is a convergence of rates within the G7 but with little change or even a slight rise in the average.