Inflation abates

Last week's inflation reports indicate that inflation is abating in the major economies.

In the United States, consumer prices fell in June by 0.1 percent, the third consecutive month of decline. Consumer prices rose 1.1 percent in the 12 months to June, down from 2.0 percent in the 12 months to May.

In the euro area, consumer prices were unchanged in June compared to May. From a year earlier, consumer prices rose 1.4 percent, less than the 1.6 percent increase in May.

In China, the year-on-year rate of change in consumer prices declined to 2.9 percent in June from 3.1 percent in May.

In the United Kingdom, the annual rate of consumer price inflation fell to 3.2 percent in June from 3.4 percent in May.

So in all the major economies that released inflation data last week, the inflation rate for June was lower than that for the previous month.

Does this mean that inflation is dead? It is probably too early to say for sure. Headline inflation can be quite volatile.

In the previous cycle, for example, US headline inflation appeared to have hit a peak in early 2003. However, after declining for about a year, the annual inflation rate resumed its uptrend.

Then in 2005, inflation again appeared to have a hit a peak, but again, after declining for about a year, it resumed its uptrend before hitting its ultimate cycle peak in 2008.

Historically, inflation usually begins a sustained decline only after industry capacity utilisation has hit a peak and is already on the decline. In the current cycle, industry capacity utilisation has not reached an obvious peak, suggesting that the recent decline in inflation could be temporary.

Having said that, last week, a Federal Reserve report showed that the recovery in US industry capacity utilisation may have stalled, the utilisation rate remaining unchanged in June from the previous month at 74.1 percent. Industrial production rose just 0.1 percent in June and manufacturing output actually contracted 0.4 percent.

Furthermore, the outlook for manufacturing is poor, with a likelihood of further declines in output ahead (see "US manufacturing recovery may be about to end"). With industry capacity utilisation still well below its 1972-2009 average of 80.6 percent, a contraction in manufacturing activity would only exacerbate the resource slack and eventually put downward pressure on prices in general.

So while the experience from the last cycle shows that we cannot rule out another upturn in inflation in the near term, the longer-term outlook is for inflation to remain subdued.