Is European Disinflation/Deflation Coming To The U.S.?

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by: James Picerno

The sharp drop in the annual rate of consumer price inflation in the eurozone in October (0.7% vs. 1.1% for the previous month) looks like a warning sign that the winds of disinflation/deflation are strengthening (pdf). If so, that’s an ominous trend given the feeble growth rate for Europe overall. No wonder that the European Central Bank announced an unexpected cut in interest rates earlier this month. One threatening report isn’t a trend, however, and so it’s unclear if October’s weak inflation report is a sign of things to come or just a one-time quirk. We’ll know more when we see the inflation report for November. Meantime, what about the U.S.? Is inflation decelerating here as well? The answer depends on your preference for estimating inflation.

Let’s begin with the implied inflation forecast based on the yield spread for the nominal 10-year Treasury Note less its inflation-indexed counterpart. For the past two months, this measure of inflation expectations has remained stable, bumping along the 2.1%-to-2.2% range, or just over the Federal Reserve’s 2% inflation target.


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The Billion Prices Project @ MIT, an independent estimate, also pegs inflation around the 2% rate lately.

The view looks more threatening by way of the Labor Department’s formal estimate of consumer inflation. The annual rate of inflation for the headline consumer price index (CPI) slipped to 1.2% in the September update, or near the lowest pace in three years (red line in graph below). For the moment, however, this is less threatening than it appears since the core rate of inflation (excluding energy and food prices) remains stable, albeit at a rate moderately below the Fed’s 2% target (blue line). Unless we see core inflation trending lower in the months ahead, it’s reasonable to assume that the soft headline numbers of late are noise.


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The Cleveland Fed’s estimate of inflation expectations also pegs the outlook at just below the Fed’s 2% target. The October 30 update shows the 10-year expected inflation rate at 1.73%, or roughly unchanged relative to the last several months.

A more troubling estimate of inflation’s trend can be found in the personal consumption expenditure (PCE) benchmark, as calculated by the Bureau of Economic Analysis. According to this data, inflation is fading: the headline PCE index increased a mere 0.9% in September vs. a year ago, or down from the 1.1% rate in August (blue line in chart below). That matches April's rate as the lowest pace since 2009. Core PCE looks a bit more stable (red line), although here too the inflation rate is hovering at a low level of just over 1%.


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Looking at all the numbers presents a mixed bag for deciding if inflation in the U.S. is set to take an unhealthy turn lower. But this much is clear: at this stage, a further decline in pricing pressure would be a dark sign for the economy. The only thing worse than low inflation and sluggish economic growth is low inflation that's slipping further toward the dark side if the economy is still facing headwinds.