Here is some free advice: Take inflation data with a grain of salt these next several months.
You won’t get that advice from ECB head Mario Draghi, who’s engaged in an extended round of spiking the football after pundits lauded his quantitative easing (QE) program for May’s eurozone inflation uptick. Similarly, media hailed May’s uptick in British inflation which, exhale, alleviated the first ever deflationary read.
These are just the latest in a series of sketchy inflation interpretations made during this bull. Way back in 2009, folks figured the financial crisis would drive deep deflation. A few readings aside, those fears proved false. What followed was an alternating series of hot inflation and deep deflation fears, culminating most recently in early 2015’s fears the eurozone would slide into a deflationary spiral. This was how Draghi sealed the deal on QE, despite the fact it hasn’t been proven to stoke inflation anywhere else. Yet QE isn’t responsible for the eurozone’s inflation uptick. Math and oil prices are.
This time last year oil began its steep, nearly -60% peak-to-trough drop. And with it, inflation fell, as in the eurozone, UK and US, Energy ranges from about 7% to 10% of the headline consumer price index (CPI). Now, Energy prices aren’t equivalent to oil prices alone, and the US CPI Energy index’s -19.4% y/y decline in April was somewhat tamer than oil prices’ plunge. But consider: While total CPI fell -0.2% y/y in April, excluding Energy, prices rose 1.8% y/y. Energy, not sluggish demand, is what keeps inflation well below the Fed’s target.
So we’d suggest not overthinking those CPI rebounds in the UK and eurozone. A lot of this is just how year-over-year stats are tallied. On a yearly basis, the present comparison is oil prices’ peak. As we enter a period when today’s levels compare to those during last year’s energy drop (the basic year-over-year math), all else equal, it’s fairly likely you’ll see prices turn initially lower, then higher from here. Energy prices peaked last June but didn’t hit their recent low until much later—January—implying bigger base comparison declines await.[i] September’s, October’s and November’s fast declines aren’t baked into the rate yet.
But it’s all noise. The year-over-year inflation rate overstated headline prices’ decline last year, but in the next few months it likely overstates the rebound. You see, oil prices have bounced back sharply—but off a low base. If oil and energy prices remain unchanged (they won’t), then June, July, August and most specifically the fall, will see a comparison of Energy prices based on oil at around $60 versus the $80 to $90 range, more “deflation”! Even though Energy prices would be up from January. If prices remain in the current neighborhood in December and January, when the base comparison drops to the $40 to $50-ish range, it will register as inflation even though price levels were still higher two years earlier. The current dips and potential future bounces are entirely due to how year-over-year CPI is tallied.
This, folks, is why most central bank policies hinge on core CPI. Yes, you must pay for gasoline and food. But that doesn’t mean the Fed (et al) should account for energy and food prices. As the last year alone shows, you can see a wild swing in the impact of volatile categories in less than a year. Central banks’ reacting to those swings could result in some odd monetary policy.
There is a symphony of noise baked into inflation data right now. We’d merely advise you not overthink any of it. Deflation and inflation, troubling or no, there will be a period—perhaps nine months or more—where CPI deserves skepticism. Don’t get fooled by statistical quirks that say more about math than monetary policy.
[i] Oil prices’ most recent low occurred mid-March, but the CPI Energy Index bottomed in January.