Forget deflation or disinflation - for the first time in ages, inflation expectations are moving higher

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Amidst the rebound in global crude prices from January something else has been following suit – global inflation expectations.

Soc Gen, in an excellent note released over the weekend, suggest that a “slow turn” in global inflation expectations is currently under way.

As the chart below shows, inflation expectations in the US, Eurozone and Japan have all been rising since mid-January – around the same time crude prices bottomed following a savage six-month bear market that saw the price slide around 60%.

The chart shows 5-year inflation swaps – the average inflation level investors believe will be seen 5 to 10-years ahead – have been steadily rising in recent months. While the moves to date have been limited – long-term inflation expectations still remain well below the levels targeted by the Fed, ECB and BoJ – it is clear that expectations have been adjusted higher in line with the recovery in crude prices, something that is reflected in the chart below.

Indeed, as another chart shows, inflation expectations in 2016 are significantly higher than where they currently sit at present.

While the recovery in crude largely explains the near-term upward revision in inflation expectations, should the price rebound be sustained (or even build) in the second half of the year, it’s highly likely that actual inflation, rather than expectations, will start to accelerate as the impact of lower energy prices in 2014 diminishes.

Coupled with strengthening labour markets, the increase in inflation, if sustained, could see central banks – starting with the US and UK – begin to normalise monetary policy far sooner than what financial markets currently suggest.

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