The Oil Market Just Keeps Tearing Up Draghi's Inflation Forecasts

A 1% inflation average next year may already be too much to hope for

The oil market doesn’t seem to care about Mario Draghi’s inflation target.

Less than two weeks after the European Central Bank president unveiled a beefed-up stimulus program to push inflation back toward its 2 percent target, fresh falls in the price of crude may have already undermined his efforts. Analysts at Nomura International Plc and JPMorgan Chase & Co. say Draghi’s December forecast of 1 percent average inflation in 2016 may be too ambitious.

Charles St-Arnaud and Sam Bonney at Nomura have found that the 25-percent slump in the WTI oil benchmark since the end of October may already be casting its shadow over inflation next year. They've calculated the so-called base effects -- the contribution of outsized price swings in one year to the following year’s annual inflation rate -- that they see as likely to have an impact in 2016.

The oil-price drop we've just seen may halve the base effect in some months next year, they write. And that could keep a tight lid on gains in the headline inflation rate, now just at 0.1 percent.


“A weaker base effect early next year means that headline inflation should remain lower than we estimated only a couple of weeks ago,” the analysts say in a note to clients. “Whereas before we saw eurozone inflation reaching 1 percent in early 2016, the weaker oil prices could mean that headline inflation only reaches 0.5 percent to 0.6 percent.”

In its December round of staff forecasts, the ECB staff based their prediction of 1 percent inflation in 2016 and 1.6 percent in 2017 on an average price for Brent of $52.2 and $57.5, respectively. However, Brent is now below $40 a barrel. 

If that's maintained, euro-area inflation won’t meet the 1 percent average forecast, writes JPMorgan’s Raphael Brun-Aguerre. And if it falls to $20, the euro-area would be in outright deflation, his projections show. 

To be sure, the ECB targets inflation over the medium term, not a one-year horizon. But with economic growth in the 19-nation region far too weak to spur home-grown price gains, meeting the goal has devolved into a market tussle far beyond the grasp of Draghi's quantitative easing. 


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