Inflation persists across the G7 economies

Central banks in the G7 economies are dealing with persistent inflation within a slowing global economy—also known as stagflation.

While the central banks have targeted an inflation rate of 2%, only Canada and France have kept inflation below that rate for most of the past 12 months, primarily as a function of their soft economies.

The inflation rate in the euro area recently stood at 2.4%, while Japan and the UK have averaged above 3%.

Varying responses to inflation

Despite sticky inflation, only the United States and Canada cut their policy rates in September, in response to their slowing economies and labor market uncertainty.

The overnight index swap (OIS) market is now anticipating that the Federal Reserve will reduce the rate by another 50 basis points through the end of the year and that the Bank of Canada will make one more rate reduction.

Other G7 central banks have responded differently, however, as they wait to see the full impact of U.S. tariffs. 

In the UK and Japan, the OIS market sees little chance of additional rate cuts, even though inflation in both countries has averaged more than a percentage point above their 2% target over the past 12 months.

During that time, unemployment in the UK increased to 4.7% in July from 3.6% in 2022, with real growth of gross domestic product reaching only 1.4%.

Japan’s economy has avoided a recession but remains sluggish. With a new prime minister, Sanae Takaichi, advocating fiscal expansionary policies and a more accommodative monetary policy, investors have scaled back expectations of a rate hike to a 27% probability, down from 60% last week.

Among the euro area economies, France’s inflation recently stood at 1.1% and Germany’s was 2.4%.

But even with France’s unemployment rate at 7.3% and Germany’s manufacturing sector reeling from China Shock 2.0, the OIS market anticipates the European Central Bank will pause its rate cuts.

In that case, the narrowing interest rate differential would bolster the euro and have a moderating effect on Europe’s inflation.

With most G7 countries deep into a postpandemic interest rate regime change, conditions are coalescing for higher inflation across most of the advanced economies.