Inflation holds the key to whether the global economy will sink or swim next year – so it’s little surprise that so much research is being done on what consumer inflation is likely to do next year, and why. 

The challenge facing forecasters is that, although inflation rates across the different countries may be at multidecade highs, different economic forces drove the prices up and will do so on the way down too.

We got a taste of this when South Africa’s consumer price inflation rate overshot expectations this week, not long after the US consumer inflation came in below expectations.  

The diversity of past and future inflation experiences is highlighted in the OECD’s latest Economic Outlook, which maps out its members’ likely trajectory of inflation through to 2024 – with the shape of the recovery from high inflation differing significantly from country to country.

The US is expected to see a material decline in inflation to below 4% next year, before almost halving in 2024 to bring it in line with the US Federal Reserve’s inflation target. 

In contrast, Germany’s inflation rate is expected to remain higher at around 8% during 2023, as Europe contends with delayed increases in the retail prices of electricity and gas, and then decline to 3.3% the following year.

South African inflation, which came in at 7.6% in October, is expected to gradually decline to just below 6% next year and then continue falling to 4.8% the following year. That will bring it close to the SA Reserve Bank’s desired level of inflation of 4.5% – in the middle of its 3% to 6% target range. 

In its analysis, the OECD notes that although price pressures will ease over the next couple of years, high inflation is likely to remain higher for longer in many economies than previously foreseen. 

It expects overall OECD inflation to decline from 9.4% in 2022 to 6.5% in 2023 and 5.1% in 2024, and notes: “Inflationary pressures are projected to ease in all countries, but this is likely to take some time in those with very tight labour markets and broad-based inflation pressures at present.”

The broad-based inflation pressures pose the biggest challenge for central banks – and the reason high inflation is hanging around for longer. 

Encapsulated in core inflation measures, these exclude traditionally far more volatile energy and food prices, which have come off significantly from their highs in the wake of Russia’s invasion of Ukraine in February this year.  

Until core inflation measures begin to decline, central banks will maintain their hyper-hawkish fight against inflation – as evidenced in the New Zealand central bank raising its official interest rate by 75 basis points this week and, more importantly, admitting that the debate was not between 50bps and 75bps, but between 75bps and 100bps.

In South Africa, core inflation was the main source of the upside surprise, says Absa chief economist Peter Worthington. The core Consumer Price Index increased 5% year on year versus the 4.8% he expected which, he says, signals that inflation is continuing to broaden beyond the energy and food price shocks.

The SA Reserve Bank’s concern with these broad-based price increases saw it raise the repo rate by 75 basis points as expected and assesses that inflation risks are to the upside. But it plans to look through temporary price shocks, of which the higher-than-expected inflation rate in October may be considered as such, after inflation looked like it may have peaked the month before.

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 Inflation is peaking – how fast will it fall? 

Oxford Economics says that for headline inflation to fall substantially below target over the next couple of years, “core inflation will need to fall much more sharply than it did when the world entered the GFC [global financial crisis].” 

Director of Global Macro Research Ben May looked at what inflation did after previous upward spikes to get a sense of what we could expect from inflation in the next few years.

He found that drawing insights from the way inflation behaved in the early 2000s was more useful than the 1970s high inflation era because there were more commonalities in monetary policy (inflation targeting was in place then), labour market regulations and the broader global economic order then.

In particular, May finds the current inflation surge has obvious similarities with the spike in inflation in the global financial crisis between 2008 and 2009, namely, they are both global and a result of energy and food price rises. The one material difference, however, is the way core inflation has behaved, and his research quantifies the extent of the challenge faced by central banks that are contending with broad-based price pressures.

According to his calculations, if both food and energy inflation declined to zero by mid-2023, core inflation would need to fall between 2.5% and 3% to enable headline consumer inflation rates in the US and Europe to come in at about 2%. 

If core inflation remained at current levels, food and/or energy price increases would need to be significantly negative to see headline inflation break below 2%.

Says May: “Still, we doubt that a combination of below-target headline inflation combined with well-above-target core inflation would be the kind of scenario that would provide central banks with a great deal of comfort and the cover to trigger a central bank pivot to rate cuts.” 

The key determinant of whether core inflation will subside is if consumer demand subsides sufficiently and supply-side pressures ease. 

Central banks have more control over the former because rising interest rates have traditionally quelled consumer demand, but have little direct influence over supply-side pressures. Thus, the extent to which supply-side pressures have contributed to high inflation in the different countries gives some indication of what to expect from inflation next year, against a backdrop of growing evidence that supply chain bottlenecks are easing.

The OECD has contributed some valuable analysis to make sense of this, breaking down member country inflation rates into supply and demand-driven inflation. It sets the scene: 

“The increase in inflation rates over the past two years in economies around the world has created major challenges for policymakers. One key uncertainty has been whether the surge in inflation has primarily reflected demand factors or negative supply shocks. That question cannot be answered precisely or with certainty, but it is possible to distinguish between demand and supply factors in an approximate way.”

According to its research, the proportion of inflation driven by demand in the second quarter of 2022 ranged from 25% in Korea to 50% in the UK and Canada. Supply factors account for about half of the inflation rate in eight of the countries, and significantly more than half in Denmark, Korea and Sweden. 

Third-quarter data in the US show that demand-driven price pressures have been broadly stable for a few quarters, it says.

This research highlights the diverse nature of inflationary pressures across the world and the fact that policymakers cannot adopt a one-size-fits-all approach and expect to have similar results. 

Thus, those hoping to get a clear picture of what to expect next year, will be sorely disappointed. 

There are so many moving parts that the bottom line is that the picture is only likely to get more complicated next year – and it’s probably best to surrender and sit back and watch how, and how fast, historic price increases unwind from country to country. BM/DM