Unemployment in the US is below 4%, the lowest level in nearly 50 years, and hourly wages are accelerating at a rate observed only before the global financial crisis (Chart 1). However, the extremely tight labour market conditions should not necessarily be interpreted as signalling potential overheating and a more contractionary monetary policy.
Our Phillips curve estimates, which link labour market conditions to the consumer inflation measure targeted by the FED (i.e., Personal Consumption Expenditure; see Prometeia Discussion Note, March 2018), show that the reaction of inflation to labour market conditions has decreased in recent years. Consequently, even in the short-medium term, the impact on inflation of further labour market improvements will be limited. Prometeia forecasts do not include any such improvements given the downward revision to expected growth in 2019.
Also, in the medium term, other cost variables not linked directly to the labour market, such as the oil price and the prices of imported goods more generally, should have a downward effect, while inflation expectations remain anchored at around 2%. Chart 2 provides a breakdown of US inflation (expressed as the deviation from 2%) into its determinants, over a three-year projection horizon.
Overall, the likelihood remains low that the US will enter a high inflation regime. The FED’s cautious attitude towards the pace of monetary policy normalization in the context of a weakening global outlook is unlikely to be compromised by an unexpected increase in wage inflation.