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Inflation Observatory

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The decline in headline prices eases

Thu, Nov 19 2009, 08:14 GMT
by BBVA Bancomer Team

BBVA Bancomer

• Rising energy prices contribute 1pp to headline inflation
• Downward pressures on core inflation remain prevalent
• Prices of new and used vehicles support core inflation

Core inflation remains stable

Headline inflation rose 0.3% in October, following a 0.2% increase in September. The difference is credited to stronger growth in energy prices, which rose 1.5%, compared to 0.6% in the previous month. Rising prices of both household energy and gasoline contributed equally to the increase. Food prices, which have been declining at an average rate of 0.1% in 2009, rose 0.1% due to an increase in food away from home. On a year-over-year (yoy) basis, the decline in headline prices eased to -0.3%. The negative figure is due to energy prices, which dropped 14.1% yoy. Since the steep decline in energy prices began in October 2008, we expect headline inflation to turn positive again in the next few months.

Excluding food and energy, core prices rose 0.2%, consistent with the average monthly rate for 2009, but price pressures were not widespread. The most significant contributors to core inflation in October were new and used vehicles, for which prices rose 1.6% and 3.4% respectively. These increases most likely reflect an adjustment due to the end of the Cash for Clunkers program, which had depressed auto prices. Furthermore, used car prices have been rising at an above average rate for the past three months, which could be due to a shift in demand from new to used autos as access to credit is limited and consumers spend more cautiously. Also of note, the shelter price index exhibited no change for the second month in a row. While owners’ equivalent rent remained the same, rental prices shifted down by 0.1% for the second consecutive month, illustrating that the market is now responding to the decline in home prices in 2009. Core prices are 1.7% above those of last year and are consistent with our scenario of low but positive inflation.

Inflation is expected to remain low but positive

While we expect core inflation to remain positive, significant downside pressures will keep it low. Economic slack, as evidenced by the 10.2% unemployment rate, is still prevalent. Given the surplus of job applicants, employers do not have an incentive to raise wages. Furthermore, many companies will not increase prices in light of the current environment of weak demand. Meanwhile, stagnant wages, combined with falling producer prices, will permit businesses to still turn a profit. Taking the current environment into consideration, we maintain our forecast of positive but low inflation in 2010 and our expectation that the target interest rate will remain low for a prolonged period.

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Published on  Thu, Nov 19 2009, 08:14 GMT