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Don't Worry if Headline CPI Reaches 5%

Wed, Jun 18 2008, 08:41 GMT
by Alejandro Neut

BBVA Bancomer

• • Headline inflation is likely to reach a 17-year high
  

• • Consumers’ 1- year-ahead inflation expectations rose to 5.2%, not seen since 1982
  

• • Although risks to core inflation have intensified, we expect it to remain stable

• • These trends are still consistent with a pause in monetary policy
  

Pressures from oil and food prices persist

As anticipated, after the lower than expected headline readings in April, inflation rebounded in May to a seasonally adjusted 0.6% (4.1% yoy). Once again, the main factors behind aggregate inflation were energy and food prices. Oil prices rose to more than 130 dollars a barrel in May, pushing energy prices up 4.4% mom (equivalent to 16.9% rise since May 2007). Food prices also continued to rise, but at a lower rate than the surprisingly high 0.9% increase seen in April. This time, food prices rose 0.3% mom (equivalent to a 5% increase since May 2007). Cereal was yet again the food sub-sector that increased the most, rising 1.6% (equivalent to 10.5% increase since May 2007).

On the other hand, prices in the housing sector were contained, with owners’ equivalent rent rising only 0.1% (equivalent to a 2.6% increase since May 2007). Prices on apparel also offset inflationary pressures, going down -0.3% (equivalent to a reduction of -0.6% since May 2007). As a result, all major trends observed in previous months were maintained in May, none showing any signs of receding.

Core inflation withstands the pressure

Core inflation readings gave no signs of pass-trough (0.2% increase in May, equivalent to 2.3% yoy), though upside risks remain and pressures intensified. Not surprisingly, inflation expectations are edging up, recessionary sentiments notwithstanding. Consumers seem to be discounting ever higher inflation for the next year; 1- year-ahead inflation expectations – from the U. of Michigan- rose again in May to a high 5.2%, not seen since 1982. We expect several of these pressures to subside as oil prices adjust down and consumers continue to be hit hard by recessionary winds. Unit Labor Costs continue to decelerate, as unemployment rate hit 5.5% in May. Economic slack will increase further as the economy slows down. Thus, we expect core inflation to remain stable, but with increasing upside risk if oil prices do not correct down. Finally, in a context of downside risks to economic growth and rising inflationary pressures, Fed is likely to keep rates unchanged until inflationary risk clearly outweigh the risks to growth.

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Published on  Wed, Jun 18 2008, 08:46 GMT