Thursday, November 18, 2010

US Inflation

US core inflation hit 0.6% in the year to October 2010, its smallest increase in data stretching back to 1957. That’s the result of its third consecutive monthly “no change” in seasonally adjusted terms. Headline inflation posted a 0.2% s.a. increase, lower than the market expectation of 0.3%. The annual headline rate rose to 1.2% in October, up from 1.1% in September.

A couple of points are worth noting. As we have discussed before, it is not surprising that core US inflation continues to drift lower. The US recovery is in a soft patch: the inventory cycle has run its course and the momentum provided to growth from stimulus measures is on the wane, but final private demand is not yet sufficiently strong to fill the gap. Households are still deleveraging (which bodes well for future growth) and the structural rebalancing (non-tradeable to tradeable) required in the US will take time. The US is the “mature” economy we are most optimistic about achieving the necessary structural rebalancing and avoiding a period of debilitating deflation. The same can’t be said of some European countries.

The other point to note is that that we have, for a long time now, been optimistic about the outlook for commodities. This has been a function of our view of how the post-GFC recovery would unfold i.e. productive sector/emerging market led. This is one of the key areas of divergence in view between ourselves and the likes of the IMF who have a somewhat more sanguine view of the outlook for commodities and future inflation from that source. We are therefore not surprised to see a gap opening up again betwwen headline and core inflation, the difference being food and energy (commodity) prices.

This result today will be a fillip for the QEII supporters. Our view remains that QEII will do little to expedite the necessary rebalancing in the US economy. It’s just going to take time!! In the meantime, disinflation will remain the order of the day.