A post in January 2010 suggested that the UK "output gap" (i.e. the shortfall of GDP relative to normal supply capacity) was 2% rather than 5-7%, as claimed by official forecasters at the time. This was a key reason for expecting inflation to continue to overshoot official and market expectations.

Forecasters, similarly, believed that the US output gap was large in early 2010 and would exert significant downward pressure on "core" inflation. This prediction, for a while, proved more successful than its UK equivalent – the annual increase in the CPI excluding food and energy slowed from 1.8% in December 2009 to 0.6% in October 2010.

CPI ex. food and energy inflation, however, has rebounded since late 2010, reaching 1.3% in April. An alternative core measure also excluding housing costs is running at 1.6%, in the middle of its range in recent years – see first chart.

The failure of core inflation to sustain a significant decline suggests that, as in the UK, the US output gap has been overestimated. This is supported by survey evidence. The second chart shows the OECD's estimate of the gap – representative of the consensus view – together with an economy-wide operating rate derived from the ISM's semi-annual business survey (a weighted average of manufacturing and non-manufacturing rates). The two measures have diverged since late 2009, with the current ISM reading consistent with an output gap of only about 1% rather than more than 3%, as claimed by the OECD.

Spare capacity, therefore, may offer limited check to an upswing in core inflation caused by monetary loosening and associated dollar weakness.