Looking at inflation projections in the UK, forecasts set to exceed 5% may seem unthinkable to many. The global economy has created an unwaveringly low-inflation, low-interest environment over the past two decades leaving today’s inflation forecasts looking like something of an anomaly. With inflation above target but still at levels seen as recently as within the post-referendum era in the UK, the path ahead may still quite rightly seem some way off. However, yesterday’s data readings particularly in the United States show us that those projections are becoming a reality elsewhere and setting in rapidly.
Measuring the change in price level is challenging. There are many ways to do it but one of the most popular methods is to track the change in price of a basket of goods over a period of time. Of course, as consumer patterns, technologies and preferences change so too must the basket of goods and services being measured. For example, in the 2004 basket, the CD Rom was added with reference to internet sales replacing the personal stereo radio cassette. Five years ago, 12 years on, the CD Rom in turn was removed from the basket given the increase in downloads, streaming and software technology. The point is, it’s an imperfect measure but one that is trusted to give a reasonable representation of the changing prices of goods over time.
Critically, in the United States, CPI is not the main instrument targeted for price stability at the US monetary authority, the Federal Reserve. They instead look at ‘core personal consumption expenditures’, which notably excludes food and energy costs. CPI is however an important part of US treasury pricing and particularly inflation-protected issuances. This CPI data was read yesterday in the US and contrary to the forecast of a 0.6% month-on-month price rise, CPI inflation was recorded at 0.9%. Of course, this is data for comparison between September and October, however the price level observed creates a year-on-year price increase of 6.2%.
The inflation reading would be even more staggering if published as an annualised rate as we often see used to emphasise the severity of an individual data point – no scaremongering here however. The conclusion from the above-consensus inflation reading was that the Federal Reserve will be forced to continue to stand by its tapering mantra with expectations shifting towards a speeding up rather than constraining the rate of monetary normalisation. The implications for US treasury and cash yields is positive attracting demand to the US Dollar. In return EURUSD tested recent lows, close to 1.15. This level is critical, matching lows reached in October. There is very little technical resistance below this level and given normalising USD positioning and the concerns surrounding the Euro, it should not be taken for certain that this level will attract sufficient Euro demand to be defended.
Discussion and Analysis by Charles Porter