Where crude oil prices move, inflationary pressures tend to follow

Joe Raedle/Getty Images
  • Inflationary pressures around the world have been slowly building in recent years. However, that may be about to change.
  • Crude oil prices have tumbled over the past two months, and where they move, headline inflation tends to follow.
  • While central banks tend to focus on underlying inflationary pressures, headline measures are influential on inflation expectations and wage negotiations, meaning the likelihood of an energy-led deceleration in the period ahead cannot be entirely ignored.

Inflationary pressures have been rising around the world in recent years, helped by stronger global growth, lower unemployment and, as a consequence of both, a modest increase in wage pressures.

Higher commodity prices have been another factor, especially crude oil which has soared from the cyclical nadir struck in early 2016.

The inflationary impulse over this period has allowed many major central banks to begin or move towards normalising monetary policy settings.

However, that could all be about to change, courtesy of the recent plunge in crude prices.

As seen in the chart from Macquarie Bank, where Brent crude prices move, headline inflation in G7 economies — the largest of the largest — tends to follow.

Macquarie Bank

While central banks tend to pay more attention to underlying inflation, rather than headline price movements, given the influence the latter has on inflation expectations and wage negations, the recent plunge in crude oil prices — especially if sustained — points to growing headwinds for higher inflation in the period ahead.

And while tight labour market conditions may be able to offset some of this impact, should they too begin to soften on the back of a slowdown in the global economy, the prospects for normalising monetary policy settings will likely dim a little further.

Definitely something to keep an eye on should crude prices hold or fall from current levels.

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