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Euroland and US: Inflation falling

Wed, Aug 20 2008, 07:06 GMT
by Danske Research EmergingMarkets Team

Danske Bank A/S

• The rapid increase in food and energy prices over the past year has boosted headline inflation in both Euroland and the US to levels not seen since the early 1990s. Speculation concerning the outlook for inflation given recent oil price developments has proliferated. In the following discussion we try to as-sess the direct impact on future inflation of three oil price scenarios and the implications for mone-tary policy.
• Our analysis reasonably concludes that Euroland headline inflation peaked at 4.0% in June and July. Also, as baseline effects begin to kick in around October inflation rates will start to decline. In other words, the period in which inflation has been running at double the ECB target (close to but below 2%) is coming to an end. If oil prices fall faster than our main scenario assumes the case for an ECB rate cut seems increasingly likely.
• A significant boost to oil prices is needed to keep US inflation rates soaring as favourable base effects will kick in by end-2008. According to even our high oil price scenario inflation will peak at 6.0% in early-2009, subsequently following a relatively steep downward trend. A significant spike in oil prices will exacerbate ongoing differences between FOMC hawks and doves. Although the trade-off between growth and inflation risks will become increasingly difficult, nevertheless even if oil prices behave as assumed by our high oil price scenario and inflation follows that path, it will probably not be enough to trigger a Fed rate hike, provided inflation expectations remain contained.

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Published on  Wed, Aug 20 2008, 07:09 GMT