Inflation has been sticky in the final leg of its descent. Our developed market headline inflation aggregate has been stuck in the 2-4% region for more than a year, while core inflation has been even more elevated
Talk of ‘reflation’ is gathering momentum. With inflation still above-target, how should we view this risk?
To answer this question, the four main categories of headline Consumer Prices Index (CPI) inflation are examined below: energy, food, goods and services (the latter two are core inflation).
Energy and food CPI: Wholesale prices continue to ris
Energy CPI inflation has been deflationary in both the US and Europe for the most part of 2024 (prices have been outright falling).
The US energy component is largely shaped by gasoline prices, which are highly sensitive to changes in crude oil prices. The latter is still priced towards the lower end of its one-year trading range, and another Trump term – in which he has pledged to “drill, baby, drill” – could mean these low prices persist. While conflict in the Middle East threatens to disrupt supply, global production is at least far more diversified today.
Conversely, wholesale natural gas prices have risen by almost 50% this year in Europe, and may start to push energy inflation higher. Importantly, however, it is unlikely to surge as it did at the start of that conflict: wholesale gas prices are still close to 90% below their summer 2022 high.
Food CPI inflation has been subdued this year as well, though not outright deflationary. That said, prices at the wholesale level have been gently drifting higher in 2024: the UN Food and Agriculture Organisation’s World Food Price Index is up by nearly 10%, with broad-based increases across food sub-indices. This increase is yet to be reflected at the consumer level, as there tends to be long lags between wholesale price developments and the prices we see on our supermarket shelves. Again, food CPI inflation could return in 2025, albeit on a much smaller scale than in the first wave.
Goods CPI: Tariff threat
Goods CPI inflation has also been muted this year, despite supply chains being tested again. Notably, the Houthi attacks in the Red Sea continue to affect Asia-Europe shipping routes, with fleets being diverted around Africa’s Cape of Good Hope. Spot container rates initially propelled higher but have moderated a little since, as shippers have adapted to the ongoing disruptions.
For now, aggregate global supply chain conditions remain healthy. The New York Fed’s Global Supply Chain Pressure Index, which combines supply-related business surveys with transportation cost data, has signalled no major stress since the initial pandemic shock .
Standard deviations from long-run average
Trump’s tariff threats are one visible looming inflationary risk, but much depends on how big and broadly they are applied. US goods inflation was little changed by them in his first term, which reflected the narrow scope of products affected and the offsetting impact of a firmer dollar. The burden of that duty may also be shared: for example, exporters and importers may bear some of that higher cost via lower profit margins – particularly for more ‘elastic demand’ products – limiting the pass-through to final consumer prices.
Moreover, while the impact of higher tariffs might point to higher prices initially, a much more protracted trade war would ultimately be deflationary, insofar as it would hit aggregate demand and real output. Of course, this unlikely to be Trump’s end goal (as noted in our latest Market Perspective).
Services CPI: Labour markets remain tight
Clearly, then, services CPI inflation, which accounts for more than half of the US CPI basket, is currently the stickiest part of the inflation equation. It is running at 5% (year-on-year) in the US and UK, and 4% in the eurozone.
While it has cooled down, further disinflation progress is likely to be gradual next year. Labour markets are tight and unemployment low on both sides of the Atlantic. Subsequently, wages – the single biggest input cost for most service sector companies – are still growing at an above-trend pace. What’s more, if Trump begins to deport undocumented workers – which are estimated to account for 4-5% of total US employment – then labour supply will fall, keeping those US wages elevated next year. However, the logistics (and morals) behind mass deportation remain questionable.
With economies being close to full employment and fiscal policy becoming looser, overall demand for goods and services – and, in turn, consumer prices – should remain firm.
Promisingly, shelter CPI inflation, which accounts for most of that services component, should continue to abate in 2025, as it tends to lag real-time house and rental price developments by roughly a year due to the way it is measured. Even so, we have been surprised at how slowly it has been fading.