Global Macro Weekly Digest (Issue 93):Inflation data this we
This week, the US and Eurozone will release two inflation indicators: the US July PCE inflation and the Eurozone August HICP inflation. Given the US’s near-full-employment job market and the Eurozone’s solid economic recovery, inflation developments have become the key determinant for the two central banks in making their monetary policies later this year. As the wage growths in both economies still stay weak, as well as the previous lift from energy prices has faded and some specific industrial changes have created a notable drag on price levels, we do not expect to see significantly strengthened inflationary pressures in either of the economies.
This week, the US Bureau of Labor Statistics (BLS) will release August CPI inflation data on Thursday (September 14th) which will provide the first look at the inflation development in August. As the Fed’s preferred inflation measure, the PCE inflation, will not be updated until September 29th, the August CPI data could provide important information on inflation during the last month for the Fed’s September meeting on September 20th - 21st. In our view, the recent recovery of energy prices as well as the weakness of the dollar could both provide the lift to the headline CPI inflation; but the underlying price pressure is expected to remain subdued, with core CPI remaining at around 1.7% YoY.
For the US, the minutes of Fed’s July monetary policy meeting stated clearly that the lack of inflation has become a concern, at least for some members. Fueled by Trump’s stimulus fiscal plan and the recovery of crude oil prices, the US’s inflation reached its highest level in February, with the headline CPI at 2.7% YoY, core CPI at 2.2% YoY, headline PCE at 2.2% YoY and the Fed’s preferred measure, core PCE, at 1.9% YoY. Afterwards, all inflation measures turned to continuous drops, falling back to around 1.4% YoY for PCE measures in June, and 1.7% YoY for CPI measures in July. Given the still falling inflation expectations, we expect this week’s PCE data to stay around the current levels of 1.4%-1.5% YoY.
Fueled by Trump’s stimulus fiscal plan and the recovery of crude oil prices, the US’s inflation reached its highest level in February, with the headline CPI at 2.7% YoY, core CPI at 2.2% YoY, headline PCE at 2.2% YoY and the Fed’s preferred measure, core PCE, at 1.9% YoY. Afterwards, all inflation measures turned to continuous drops, falling back to 1.4% YoY for PCE measures, and 1.7% YoY for CPI measures in July. However, the recent recovery of energy prices should help lift the headline inflation. Also, the recent depreciation of the dollar has led to a mild increase in inflation expectations. Thus, we expect the August CPI to pick up in its headline measure, but the core CPI could stay around the July’s reading.
Specifically, despite the lackluster wage growth, which explains why we have not seen a strong uptick of core inflation in the US, other industry specific changes also contributed to the drop of US’s core PCE data. 1) the recent price war in the telecom industry has significantly dragged down the telecommunication services price by around -9% YoY since March, which caused around 0.1 ppt fall in headline PCE inflation; 2) the price growth of financial services significantly decreased from around 6% YoY in January to 3.3% YoY in June. But unlike the telecommunication services the financial services price surged during last year and the recent drop in price growth is just returning to its 10-year average level. Together, the price fall of telecommunication services and the decelerated price growth of financial services have contributed to around 0.25 ppts fall of the headline PCE or almost 0.3 ppts fall of the core PCE this year. Looking forward, as the price war in the telecom industry has come to an end and the price growth of financial services has dropped back to 10-year average, these two factors’ drag on the core PCE should gradually fade. But still, we do not expect the core PCE to reach the 1Q levels, but only stabilize in the near future.
Specifically, as we have addressed in previous reports, the price fall of telecommunication services, transportation, and medical care explains the recent inflation slumber in the US. 1) the recent price war in the telecom industry has accumulatively dragged down the telecommunication services price by more than -10% this year, which caused around 0.15 ppt fall in headline CPI; 2) the decelerated price growth of medical care (falling from 4% YoY in January to 2.6% YoY in July) and transportation (falling from 5% YoY in January to 1.2% YoY in July) also caused around 0.3 ppts fall of headline CPI. Specifically, the medical care and transportation prices surged during last year and the recent drop is just returning to their 10-year average level of price growths.
For Eurozone, the region’s inflationary pressure showed some signs of mild recovery, but still not strong enough to push the HICP inflation towards the 2% target. Due to the improved outlook of economic growth, especially the solid domestic demand, the core HICP inflation is generally on an upward trend this year, increasing from 0.9% YoY in January to 1.2% YoY in July and inflation expectations have been increasing since June. However, still dragged by the weak energy prices, the overall inflation level stayed sluggish at around 1.3% YoY. For the sub-categories in HICP inflation, transportation contributed the most notable drag, but the prices of “fuels and lubricants” is the real reason behind the drag. Moreover, despite some gradual improvements, Eurozone countries continue to suffer from high unemployment and low wage growth, which will hinder the development in inflation. Thus, we expect the August HICP data to be stable at around 1.3% YoY this week.
Looking forward, as the price war in the telecom industry has come to an end and the price growths of medical care and transportation dropped back to 10-year average, these factors’ drag on CPI should gradually fade, and inflation should stabilize in the near future. By saying "stabilize", we expect no further falls, but also no significant increases, as the subdued wage growth and the depressed pricing power of companies will form notable headwinds on inflation development. Other possible boosts on inflation include: 1) strong consumption growth, 2) Trump’s tax reform in 4Q, and 3) the weak dollar effect. But such possible upside on inflation could be limited. Consumption growth could be dampened by the hurricanes, the tax reform is still in its very preliminary stage, and dollar's downside is also limited.
Based on the inflation outlook, we maintain our previous view that both the Fed and the ECB could act less aggressively in making their monetary policy decisions. The Fed could replace a third rate hike with the start of its mild balance sheet reduction; and the ECB could even announce to extend the current asset purchase program for several months before announcing the tapering, if it does not see convincing signals on improvements of inflation by its September / October meeting.
Finally, for the Fed, as we have continuously reiterated, inflation has become the more important indicator for policy decisions in the future, as the US job market is already near or at full employment. The minutes of Fed’s July meeting clearly stated the lack of inflation that companied the continued economic recovery has become a concern, at least for some members, and has caused a fissure on the timing of future rate hikes. Thus, we expect the Fed to act less aggressively regarding the possible rate hike in December, as it needs more time to understand how these conflicting forces are unfolding.
In sum, although the August headline CPI could be lifted by the rising energy prices, we maintain our view that the US inflationary pressure will remain subdued in 4Q. However, we do not expect such outlook to significantly derail the Fed’s policy trajectory, i.e., unless there are significant falls in inflation (which we do not expect to see), the start of the Fed’s balance sheet normalization in September is still well on track; and the possibility of December rate hike remains.
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