- Eurozone inflation moved into negative territory, though core inflation edged up
- Negative inflation rates will provide great mood music for Draghi to push through QE
- Fed minutes suggest rate hike likely in mid 2015, despite low US inflation
Eurozone inflation turns negative, but core rises
Eurozone inflation turned negative as expected last month. HICP fell by 0.2% yoy in December (consensus was for a 0.1% yoy fall). That was down sharply from +0.3% yoy in November. The decline was due to a sharp fall in energy and food prices. Indeed, core inflation actually rose to 0.8% yoy from 0.7% yoy, maintaining the rather flat trend that has been in place over the last year.
Headline inflation to stay negative for a while
We expect headline inflation to remain negative over the next few months. The exact path depends crucially on oil prices. If they were to remain at current levels, inflation would likely remain negative until June of this year.
Core to move sideways
Having said that, core inflation is likely to move sideways. Despite high unemployment, there is little disinflationary pressure coming from the labour market. In addition, import prices (outside of oil) will rise due to the fall in the euro. This should offset any second round effects from oil.
Deflation unlikely, but inflation goal will be missed
We think that the risk of core inflation turning negative – and hence that the eurozone falls into sustained bad deflation – is low. The fall in oil prices is positive for demand. Nevertheless, the ECB looks likely to miss its inflation goal by a significant margin over the coming years.
ECB will move to QE, with announcement in January and details in March
The case for further ECB action is strong and the negative rates of inflation will provide great mood music for Mr Draghi to push QE through the Governing Council. The Greek issue could complicate the announcement. We expect the ECB to announce that it will embark on a large scale asset purchase programme, including sovereign bonds, at its January meeting. However, it may well hold off from providing any further details until March, giving it a chance to see how the situation in Greece turns out.
Fed policymakers agree to press ahead rate hike, mid 2015 most likely
The Minutes of the FOMC meeting on 16-17 December confirmed the strong signal of Fed policymakers to tighten monetary policy in 2015. Most FOMC members agreed that it was useful to include the phrase indicating that the Committee can be patient in beginning to normalise monetary policy, as this language would provide more flexibility to adjust policy in response to incoming information. In addition, it suggested that the normalisation was unlikely to begin for at least the next couple of meetings or not earlier than April. Our view given the positive flow of data and the diminishing slack in the labour market is that the rate hike will be in June 2015.
Minutes suggest low inflation will not stop rate hike
Some FOMC participants became more confident in the economic outlook since the previous meeting and most generally regarded the effects of the decline in oil prices as positive for the US economy. The minutes noted that the
lower energy prices and stronger dollar were likely to keep inflation below target for some time, but that this should not be an impediment for normalising interest rates. Indeed the Committee mentioned that “they might begin normalisation at a time when core inflation was at current levels”.