The personal consumption expenditures price index excluding food and energy costs increased 0.4% for the month and 2.8% from a year ago, as expected according to the Dow Jones consensus estimates. 

In this definition, inflation is simply a decline in the value of money. Now clearly this decline in the value of money can occur against a basket of goods and services, but it can also occur relative to other things like physical assets, such as houses and financial assets, like stocks. And if we take this broader definition of inflation, the jury is out on whether inflation has come down very much and perhaps especially, whether it has come down sufficiently to suggest that monetary policy is tight enough.

If we go back some years, to before the pandemic, we argued that there had not really been any of the broad disinflation or deflation that was being talked about at the time; something that had made inflation-targeting central banks drive policy rates down towards, or below zero, and engage in quantitative easing.

Instead, Mr. Steve Barrow, Head of the Standard Bank G10 Strategy, said that the strength of asset prices at the time showed that inflation was rampant here, even if it was not in terms of goods and services prices. The danger of rapid asset price growth is two-fold. The first is that it can produce positive wealth effects that ultimately cause demand to outstrip supply and so lead to higher inflation in terms of goods and service prices. The second is that rapid increases in asset prices have a habit of entering a bubble and exploding at some point.

In some senses, both of these things have happened in recent years; albeit not in ways that we could have imagined. The demand/supply imbalance that led to higher goods and services inflation was generated primarily by deficient supply during the pandemic, not excess demand. And the plunge in asset prices occurred when the shock of the pandemic hit risk assets like equities very hard. Since then, goods and service inflation, as measured by the CPI has risen and then fallen. It would appear to many that the fall in inflation has been caused by the hike in policy rates and trimming of central bank balance sheets.

However, there is an alternative view, which is that the fall in inflation has occurred almost automatically because those factors driving goods and service prices up in the first place, such as the supply constraints seen during the pandemic or the surge in energy prices when Russia invaded Ukraine, have reversed.

Arguably adding weight to this view is the fact that economic growth has not collapsed under the weight of rate hikes; something that we might ordinarily expect if monetary policy was the primary reason for falling inflation. Another supporting factor is that ‘broader’ measures of inflation which take in the price of real assets, like housing, or financial assets, like equities, have quickly bounced back from any initial Covid-related slide.

In short, Mr. Steve Barrow said if we were to judge inflation as being a decline in the value of money in a very broad sense then it does look as if the disinflation within goods and services is being offset by what’s happening in asset prices. The danger here is that the wealth effects from asset price strength keep demand too strong relative to supply and so frustrates the decline in goods and services prices.

“This effect could be particularly pronounced as the cost of funding these assets – interest rates – decline. Now we know that central banks won’t be cautious about cutting rates because asset prices are riding high, but perhaps they should be just as those riding the asset price rise might need to be aware of the growing bubble risks”, emphasized Mr. Steve Barrow.