G7 headline consumer price inflation is rising sharply but “core” inflation – excluding food and energy prices – remains close to its average in recent years. Core inflation may increase in 2017-18, reflecting low G7 unemployment, “second-round” effects from the reversal in commodity prices and a permissive monetary environment. Higher core inflation may result in monetary authorities tightening policy later in 2017 despite a slowdown in economic growth (suggested by recent monetary trends – see previous post).

G7 headline CPI inflation rose to 1.8% in January, the highest since July 2014 and up from a low of zero in September 2015. Core inflation, however, was unchanged at 1.5%, close to its average of 1.4% over the last five years (i.e. 2012-16) – see first chart.

The headline / core gap is closely correlated with the annual rate of change of the S&P GSCI commodity price index. This relationship suggests that the gap will rise from 0.3 percentage points (pp) in January to about 1 pp in spring 2017 – second chart. Headline inflation, therefore, may increase to about 2.5%, assuming a stable core rate. The gap will decline later in 2017 if the GSCI index stabilises – but current economic strength could result in a further gain.

Monetary policies are likely to key off core rather than headline inflation developments. G7 core inflation may rise in 2017-18, for three reasons. First, core inflation has increased historically when the G7 unemployment rate has fallen below 6% – third chart. The rate moved below this level in March 2015; core inflation has risen by 0.2 pp since then (i.e. from 1.3% to 1.5%). The jobless rate was 5.3% in December 2016, equal to the low reached in the 2000s (2007), and may decline further in lagged response to current economic strength.

Secondly, core inflation has also risen on average historically after the headline / core gap has turned positive – fourth chart. Stronger commodity prices boost input costs for producers of core consumer goods and services, while higher headline inflation may feed back into increased wage demands. Core inflation rose significantly when a large headline / core gap last opened up in 2010-11, despite a high unemployment rate.

Thirdly, G7 narrow money has been growing strongly in recent years, suggesting a loose monetary environment that may accommodate rising core inflation. The trend decline in nominal GDP expansion between the 1970s and the 2000s reflected progressively lower peaks and troughs in narrow money growth – fifth chart. Average money growth since 2010 has exceeded the decade averages – shown by the horizontal lines in the chart – for the 1980s, 1990s and 2000s.

Global six-month real narrow money growth appears to have stabilised in January after a sharp fall in late 2016. The recent slowdown suggests that global economic momentum will cool from spring 2017, while the liquidity backdrop for markets has deteriorated.

As previously discussed, the global (i.e. G7 plus emerging E7) narrow money measure tracked here has been depressed recently by India’s “demonetisation” programme, which resulted in M1 falling by 28% between October and December, with a 5% recovery in January. This programme has hit Indian near-term economic prospects but the M1 decline overstates the impact, while the global implications are probably limited. A decision, therefore, was taken to exclude the contraction from the global narrow money measure by recalculating the aggregate keeping Indian M1 at its October level.

Even with this adjustment, global real narrow money has slowed sharply in recent months – six-month growth peaked at 5.5% (not annualised) in August 2016 and is estimated to have fallen to 2.9% in January, based on data for countries comprising two-thirds of the aggregate. Current expansion is the lowest since October 2015 – see first chart.


Turning points in global real narrow money growth have led those in industrial output or GDP growth by an average of nine months historically, with a normal range of six to 12 months. Global real money growth bottomed in August 2015, rising strongly over the subsequent year. Industrial output momentum started to pick up nine months later, i.e. from May 2016.

Based on the nine-month average lead, the fall in global real narrow money expansion since August 2016 suggests that economic growth will peak in May 2017 and decline through October. A turning point, however, could occur as early as February or as late as August. An early peak (i.e. before April) is less likely because growth of the non-monetary global leading indicator tracked here (based on the OECD’s country leading indicators) was still rising in December 2016 and has led economic growth turning points by four to five months on average historically – see previous post.

Roughly 70% of the fall in global six-month real narrow money growth since August 2016 can be attributed to a decline in nominal monetary expansion, with the remaining 30% due to higher inflation – second chart. The fall has been broadly based across countries, with the US and China making significant negative contributions – third chart.



Chinese six-month real narrow money growth fell to a 17-month low in January but remains solid by historical standards. Narrow money data can be volatile around the New Year holiday and it is possible that the January decline will be reversed, at least partially, in February. Real broad money growth was stable in January – fourth chart. The Chinese economy is expected here to perform robustly through summer 2017, at least.


US six-month real narrow money growth fell sharply into December 2016 but recovered in January. This recovery is expected here to be reversed in February: the weekly data tailed off at end-January and there is a significant negative base effect from a large monthly rise in August 2016. US monetary trends, therefore, continue to question consensus optimism about economic prospects.