Friday, December 5, 2014

Inflation - Oil and Bad Press?

"Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man" - Ronald Reagan

We had the last ECB before the holidays and before the market doubles down on its expectation of QE in January again. This is how Euro traded yesterday during the press conference

More dovish, and no actions. But action was hardly expected. We still have an TLTRO to go, and it is already almost Christmas. The positioning build up, both in Euro and in short end rates, before the meetings indicated there is a good chance of a disappointment move. And it played out more or less like that. But that should not budge the long term Euro shorts.

One important point was what Mr Draghi made clear about crude prices. For last one year, ECB has always downplayed the reduction in inflation due to energy prices, citing it as a transient and volatile component. This, for me at least, is the first time ECB showed a genuine concern that this transient impact may pass through to inflation expectation and become more permanent. ECB does not sound comfortable at all in the recent decline in crude, and in no mood to brush it aside citing energy as a volatile component any more.

This is exactly the counterpart of what happened in April 2011, when ECB unexpectedly hiked rates. ECB models are sensitive to pass through second order effect of energy inflation. This time it is acting in the favour of the doves. Keep your Euro shorts rolling.

Stepping back from ECB, and looking in to the inflation picture globally, it seems things are not as bad as made out to be. In spite of the oil crash. See these charts below

We had too much of press about deflation and disinflation this year. But globally, core inflation in fact picked up over last year (see Trend I), apart from Euro-zone. Of course the absolute level still remains uncomfortably low for many countries. And if you take a closer look you will see the chart in Trend III is remarkably similar to the first chart. Global core inflation picked up mostly driven by wage growth, in a classical manner. Change in exchange rate has lower significance on its impact on the inflation and same goes for classical money supply (note these excludes any QE or QQE).  And this also suggest the mere disparities between Euro area countries will require more innovative solutions than plain vanilla QE

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