The US CPI comes out this week, and analysts at RBS believe we’re now in the final month of the deflationary readings we’ve been getting for quite sometime.
We wonder how many analysts in Japan, in the early 90s, made similar notes about the deflationary run coming to an end, only to be nearly 20-years early.
The October US CPI on Wednesday is one of the key releases of the week: we expect a rise of 0.2% m/m as energy costs may have advanced by around 1.5% m/m. Also, we are looking for the core rate to have risen by 0.1% m/m owing to gains in education, airfares, new vehicles and medical care, offset partially by continued softness in shelter costs. Our forecast is consistent with annual CPI inflation (non-annualised) of -0.3%, which is likely to be the last negative reading of this cycle: inflation should turn positive in November after eight consecutive negative prints since March 2009.
Recently, the disagreement about the inflation outlook increased significantly among forecasters. Some are worried about the potential inflationary pressures over the medium term of widening budget deficits and the abundant liquidity provided by central banks. Others are more concerned about the downward pressure on prices that economic slack and the weakening labour market could generate. The last FOMC reiterated that with “substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable […] warrant exceptionally low levels of the federal funds rate for an extended period”. However, while trying to curb disinflationary pressures in the short term, the FOCM generates rising concerns about the longer-term outlook for inflation, complicating the FED communication strategy.
Inflation is on the turn also in the euro area: on Monday, the final reading of the October HICP will signal the last month of negative inflation in the region at -0.1% y/y, the fifth consecutive negative reading since June 2009. In November inflation should move back into positive territory; our forecast is currently tracking 0.8% y/y and 1.2% y/y for December.
In 2010, we expect inflation in the euro area to average 1.3%: the contribution from energy prices to the headline is likely to be the most significant (0.5% on average during the course of the year), followed by administered and volatile prices (0.4%), core services (0.35% on RBS measure) and a close to neutral contribution of food and core goods (RBS measure) prices inflation. At the November press conference the ECBs assessment about the inflation was unchanged, but we expect the inflation projections for 2010 to be revised up to 1.4/1.5 % from 1.2% at the December meeting, when the ECB will present an update of the Eurosystem staff macroeconomic projections.
On Tuesday, UK CPI inflation is expected to show a turning point with a rise to 1.3% in October from 1.1%, before heading to above-target levels in the first quarter of next year. The BoE remains rather dovish in its inflation outlook with the Inflation Report last week bringing a more modest than expected rise in the CPI inflation forecast: at the two-year horizon by just 0.2ppt to 1.6% against our expectation of 1.8%. This is despite a Q3 2009 starting point 0.2ppt above the previous projection of the MPC, a lower market interest rate profile (averaging almost 0.5ppt throughout 2010), a starting point for £ERI 4.1% below the August Inflation Report assumption and a more pronounced stock market rally.