G7 consumer price inflation has fallen from a peak of 3.1% in September 2011 to 1.4% by July 2012 but is likely to rebound into 2013 as recent increases in energy and food commodity costs filter through the pricing chain. Even assuming no further rise in commodity prices, the G7 headline rate may return to about 2% by early next year.


Commodity price strength is the proximate cause of the expected inflation pick-up but the fundamental driver is monetary buoyancy over 2009-2011. The second “monetarist” forecasting rule employed here, based on the empirical work of Friedman and Schwarz, is that the money supply leads prices by about two years. A smoothed measure of G7 (narrow) money growth fell between autumn 2009 and summer 2010, predicting a decline in inflation between autumn 2011 and summer 2012 – see chart below and post last year. The money measure, however, rose strongly in late 2010 and 2011, signalling that inflation would rebound in late 2012 and trend higher in 2013 – see January post. The money measure is a centred 23-month moving average so the latest available datapoint is for August 2011.

The pick-up in the G7 money measure from 2010 partly reflects a US monetary surge caused by the Fed’s QE2 operation. US money growth has slowed more recently but an offsetting recovery is occurring in the Eurozone, while the Fed is poised to launch more bond-buying. The smoothed money measure, therefore, is likely to continue to rise into 2012, in turn suggesting that the inflation uptrend will be sustained into 2014. The measure is already above its previous high reached in 2009, consistent with G7 inflation exceeding its September 2011 peak of 3.1% during 2013.

The monetarist inflation-forecasting approach has had remarkable success in recent years yet is completely ignored by a consensus wedded to failed Keynesian “output gapology” and its convenient implication that central banks must continue to inject liquidity into markets by financing the deficits of fiscally-irresponsible governments.