A post last April suggested that G7 consumer price inflation would peak in autumn 2011 and decline into 2012. Relief, however, was expected to be modest and temporary.

The forecast is on track, with annual inflation topping at 3.2% in September and down to an estimated 2.5% in December. A slowdown in commodity prices during 2011 points to a further decline in early 2012 – see first chart.

The forecast was based on the monetarist rule that money supply changes lead inflation by about two years. A smoothed measure of G7 narrow money growth rose between September 2007 and October 2009, correctly predicting the 2010-11 inflation upswing. It partially retraced this increase in 2010, reaching a trough in August, suggesting that inflation would decline from autumn 2011 to a low in summer 2012 – second chart.

The inflation slowdown has been factored into current market pricing. The smoothed money measure, however, has continued to trend higher from its August 2010 trough. The global monetary pick-up during 2011, discussed in numerous previous posts, should sustain this increase, with a possibility that the measure will surpass its 2009 high.

The monetarist rule, in other words, suggests that inflation will revive later in 2012 and into 2013, with a significant risk that it will exceed its 2011 peak next year. Recent firmer commodity prices could be early evidence of this scenario. Bond markets usually anticipate inflation, implying higher yields by the summer, although central bank manipulation may damp the move.