“The big story this year is not the US spending sequester, the China slowdown or the ongoing European recession,” says Ethan Harris, Bank of America Merrill Lynch’s top global economist.
“The big story is inflation, or more precisely, the lack thereof.”
From Harris’ note to clients on Friday:
…After peaking in the summer of 2011, inflation has steadily fallen globally and in both the emerging and developed markets economies (Chart 1) Our global inflation index goes back to 1996 and over that period inflation has averaged 3.1% overall, 1.9% in DM and 6.6% in EM; the corresponding numbers for this March were 2.2%, 1.3% and 4.0%. Of course there are some exceptions: inflation has been defying gravity in the UK for a number of years and is high in some major EM economies such as Brazil and Mexico.
The weakness has come as a surprise to economic forecasters and an even bigger surprise to many market participants. Critics of the major central banks have repeatedly warned that easy policy would lead to runaway inflation. However, in reality inflation is falling, not rising…
Harris ran 20 years worth of numbers and showed that a growing monetary base, which is happening thanks to quantitative easing, does not correlate well with inflation.
“For example, Table 1 shows the correlation between the growth in the US monetary aggregates and CPI inflation at various lag lengths,” he wrote. “The correlation is always small and half of the time has the wrong sign – strong money growth “causes” low inflation.”
Below is BAML’s inflation surprise index. As you can see, economists have been overestimating inflation around the world.
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