Why Investors Can’t be Complacent About Inflation Let Downs

Forecasters have consistently over-estimated inflation since the start of 2015

By Richard Barley


It isn’t news that global inflation is low. And yet just how low is apparently still a surprise to forecasters—at least to judge by Citigroup C 0.04 % ’s Inflation Surprise indexes, which track the performance of actual inflation against forecasts.

Only three times since the start of 2015 have the indexes for the U.S., U.K., eurozone and Japan entered positive territory, which implies inflation was higher than expected. Those occasions were in June and July 2015 for Japan and in April 2016 for the U.K. Otherwise, the indexes have shown inflation consistently undershooting expectations—even at extremely low levels.

Citigroup’s indexes don’t just look at headline consumer price inflation: they also look at wages and producer price inflation, where data and forecasts are available. That explains why the U.S. index, for instance, is still negative, despite forecasters having a better handle on headline CPI recently: wages have been the disappointment there. They are also calculated on a rolling basis, which means past forecast errors have some weight, although the latest data always have the biggest impact on the series.

Granted, economic forecasts are often unreliable. But, arguably, they should be just as likely to miss the outcome from both directions. The consistently negative readings on the Citigroup indexes implies that forecasters have been persistently over-optimistic on inflation. And that may help to explain why markets are refusing to price in predictions that inflation should pick up later this year as the effects of falling oil prices fade.

There have been false dawns before; the oil price plunge at the end of 2015 and start of 2016 pushed out a previous expectation of a rebound.

Even the European Central Bank last week appeared to err on the side of caution. It kept its forecasts for 2017 and 2018 inflation unchanged at 1.3% and 1.6% respectively, even though policy changes and oil prices were still expected to increase inflation.

Investors might be right to be cautious because inflation forecasters appear to have been crying wolf.

They need to be careful, however, because they could still suddenly find higher inflation at their door later this year. That would be a surprise markets wouldn’t take in their stride.

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