Global Daily – Has US core inflation bottomed out?

by: Aline Schuiling , Peter de Bruin

140416-Global-Daily-Insight.pdf ()
  • While US core inflation will rise only modestly in coming months, it seems to have bottomed out…
  • …this should ease FOMC members’ concern that inflation will remain low
  • Germany’s ZEW economic sentiment declines – but still signals growth

Surging food prices lift US inflation…

Consumer prices increased by 0.2% mom in March, following a 0.1% rise the month before. The outcome, which was higher than the consensus forecast of 0.1%, marked the first time in three months that monthly price gains exceeded 0.1%. Although energy prices declined by 0.1%, this was offset by a 0.4% rise in food prices. But more importantly, core consumer prices were up by 0.2% for the first time since November 2013. The 0.2% gain in both headline and core consumer prices had the effect of lifting annual inflation from 1.1% to 1.5%, while core inflation edged up from 1.6% to 1.7%.

…but core inflation also seems to have bottomed out

We think that annual core inflation has bottomed out and that it will move gradually higher during the course of this year and next year. Core inflation has trended downwards since May of 2012, reflecting that a rise in shelter inflation has been offset by falling core goods prices and lower services inflation. However, judging by producer prices, declines in core goods prices should soon start to moderate, something that was already pre-signalled by core goods prices staying flat in month in month terms in March. We also think that a stronger labour market recovery that gradually drives up wages in conjunction with a firming of demand for services will drive up services inflation again. Although rent inflation should ultimately come down when construction activity picks up, on balance, there will be upward pressure on core inflation. Indeed, we think that February marked the inflexion point for core inflation and that it will gradually move higher in coming months, reaching 2% somewhere in the beginning of next year.

Inflation increasingly to become a driving factor for financial markets

While the release of the inflation figures hardly had an impact on financial markets, we think that this will change going forward. Indeed, while fears about inflation being too low shined through the Fed’s March meeting minutes, inflation gradually moving higher should prompt FOMC members to increasingly recognize that the recovery is on a solid footing. Although there is currently an unusually large discrepancy between CPI-inflation and PCE-inflation, the two series, over time, tend to track each other pretty well. As such, core PCE inflation should also move gradually higher. In conjunction with our view that the recovery will be stronger than the Fed estimates, this should help the dots, describing FOMC members’ view of the appropriate federal funds rate for the end of 2015 and 2016 to gradually climb higher during the second half of the year.

Germany’s ZEW economic sentiment declines – but still signals growth

The ZEW economic sentiment indicator decreased from 47 in March to 43 in April. Given the historical pattern of monthly changes, this can considered to be a relatively moderate decline. Part of the decline seems to have been related to the ongoing tensions in Ukraine, but contributors to the survey (economists and financial analysts) also became slightly less optimistic about the growth outlook for the US, Japan and the UK. Last but not least, the judgment about the current economic situation rose sharply and reached its highest level since July 2011. This probably also contributed to some weakening of the expectations about growth during the next six months. Having said that, at its current level, the ZEW sentiment indicator is still well above its long-term average value of around 25, which is consistent with strong growth in the German economy. Indeed, we expect GDP growth to have picked up noticeably in Q1, when the economy received some one-off extra support from the extremely mild winter weather. Subsequently, growth will probably slow down somewhat, but remain above both the long-term average for the German economy and the eurozone total.