Death of Deflation Looms in 2016 for Those Watching Core Prices

  • Carney, Fischer, Kuroda all keeping an eye on core inflation
  • China may hold key to stabilization; Draghi may be odd man out

Inflation may finally be showing signs of life in the world’s biggest economies.

JPMorgan Chase & Co. economists’ estimate the average core rate of inflation -- which strips out food and energy costs -- in the 33 economies they monitor is running around the fastest pace for 15 years globally after increasing 2.4 percent in October. That’s given them enough confidence to declare the turning point for worldwide consumer prices.

Bank of England Governor Mark Carney, Federal Reserve Vice Chairman Stanley Fischer and Bank of Japan Governor Haruhiko Kuroda have all recently flagged core price trends, lending credence to the argument that the worst of the global deflation threat may be in the past.

“The gravitational pull is for headline rates to realign with core rates,” said David Hensley, director of global economics for JPMorgan Chase & Co. in New York. “All the developed-market central banks are looking at inflation below their comfort zone and to see it move up will make them feel better.”

And as they feel better, central banks such as the Fed may steer away from the ultra-loose monetary policy era, a shift set to start next month with markets betting on the first U.S. interest-rate rise in nine years.

The odd man out is European Central Bank chief Mario Draghi, who said Friday he and his colleagues “will do what we must” to boost price gains.

‘Imminent Rebound’

If JPMorgan is right, Draghi’s job may turn out to be easier than it now looks. Hensley reckons global inflation is on course to reach 2 percent by the end of this year and 2.6 percent in a year’s time, up from as low as 1.3 percent last January.

Goldman Sachs Group Inc. economists are also estimating the average core rate of the Group of Seven nations will move higher in the next two years and recently warned traders in the U.S. that their expectations are too low. One measure of U.S. inflation -- the 10-year break-even rate or the gap between yields on Treasury notes and inflation-linked debt of that maturity -- has already rebounded to 1.65 percent from a six-year low of about 1.38 percent in September.

“There aren’t many certainties in economic forecasting, but an imminent rebound in global inflation is one of them,” said Mark Williams, chief Asia economist at Capital Economics Ltd. in London and a former U.K. Treasury official.

Behind that confidence is the view that the recent slide toward deflation territory was propelled by the collapse of commodities, with a slowdown in China as the trigger, and that both may be stabilizing. In that scenario, inflation on an annual basis should speed up, especially in economies where labor markets have tightened, such as the U.S. and U.K.

Even lingering commodity weakness -- on display Monday with crude oil’s slide below $42 a barrel -- may not pack the same deflationary punch as it did in the past for the simple reason that the steep declines that started late last year will begin to wash through year-on-year price readings. The El Nino weather phenomenon may also boost food prices.

Permanently Weak

At the headline level, it’s still hard to spot any sign of quickening inflation almost a decade since a financial crisis tipped the world into recession and fanned deflation fears.

While policy makers have repeatedly predicted inflation to accelerate amid near-zero interest rates and other monetary stimulus program, it has failed to do so. That’s even the case in economies such as the U.S. where hiring and wages have accelerated, raising questions over whether inflation behaves as it once did or risks staying permanently weak.

Whether to care about core prices is also a long-running debate. Those who favor doing so say ignoring transitory elements such as fuel costs provides a better insight into underlying price pressures; those who prefer to monitor the overall rate argue that it reflects the everyday experience of consumers and companies better. 

One advocate for keeping an eye on the core gauge -- even though he’s not tasked with doing so -- is Bank of England Governor Carney. He told Bloomberg News this month that the U.K.’s negative headline rate is likely skewed by foreign forces, whereas the core measure of 1.1 percent provides insight into domestic inflation.

“What we want to avoid is to have cost pressures build up too much domestically to the extent that once these foreign factors ultimately pass through the economy, we’re overshooting that inflation target because of domestic strength,” Carney said.

Also projecting inflation will soon accelerate is Fed Vice Chairman Fischer. Core inflation is edging higher as Americans pay more for services including rents and medical care.

“Some of the forces holding down inflation in 2015 -- particularly those due to a stronger dollar and lower energy prices -- will begin to fade next year,” Fischer said this month.

At UBS Group AG, deputy chief U.S. economist Drew Matus says as that happens there could be a “rapid, technical, acceleration in overall inflation,” backing the Fed’s case for raising rates.

Bank of Japan Governor Kuroda says the nation’s inflation trend is improving, with his bank this year highlighting a new core measure that excludes fresh food and energy costs. After keeping policy unchanged last Thursday, the BOJ said “inflation expectations appear to be rising on the whole from a somewhat longer-term perspective.”

By contrast, ECB President Draghi is still sounding the deflationary alarm. “In making our assessment of the risks to price stability, we will not ignore the fact that inflation has already been low for some time,” he said Friday.

Yet even in Europe, the core picture looks very different from what the headline level shows. While the inflation rate in the 19-nation euro area was 0.1 percent in October, the core rate climbed to 1.1 percent -- the fastest since August 2013.

That should help lift the headline rate to 1 percent in coming quarters “so if the ECB doves are leaning toward additional easing measures, it certainly seems easier to make the argument for action in December than it might be in March,” said Marchel Alexandrovich, senior European economist at Jefferies International Ltd. in London.

Barclays Plc economists see little reason to fret about a return to the days of prices rising too quickly. They note inflation is beneath 1 percent in 90 percent of the developed markets they monitor and that it will remain “uncomfortably low” through next year, predicting 2016 core rates of 1 percent in Europe and Japan and 1.3 percent in the U.S.

Investors should nevertheless be on the alert, according to economists at Credit Suisse Group AG. While their base case is for core inflation to remain sluggish, they told clients in a report this month that acceleration in the U.S. would not be surprising given the economy’s recent growth and 5 percent unemployment.

“Such an increase, especially if it comes amid a rebound in global growth and Fed hikes, could guide markets toward expecting a steeper tightening cycle,” the Credit Suisse economists said.