In nearly ten years of expansion, US inflation has averaged 1.5% per year on the PCE index, vs a target of 2%. At cycle peak, we would expect to be above this level, to offset the underperformances during periods of recession. This is not the case, however. The central bank is increasingly concerned about the chronic low inflation rate. The monetary shift made by the Fed in recent months had its immediate origin in the sharp market correction at the end of 2018. But its fundamental justification lies in an overly low rate of inflation. The Fed now aims to restore the symmetry relative to its 2% target.
The Fed is supposed to adjust its monetary policy to promote full employment and price stability (which, in practice, is an inflation trend of 2%). No hierarchy has been set regarding these two objectives. After the crisis, the reduction of unemployment was, of course, the Fed’s primary objective. Now that full employment has been more or less restored, the Fed’s attention is more focused on inflation. Messrs Powell and Clarida have repeatedly stressed that the 2% target should be symmetrical. This is not the case. Over the past ten years, annual inflation has been around 1.5% on the PCE index and 1.7% on the CPI. In H2 2018, inflation fell sharply in line with oil prices. The new tensions on the oil market caused a rebound in March and, if current prices are extrapolated, inflation would be around 2% until next autumn, before jumping to 2.5% at the end of the year (see chart lhs). Stripping out oil, US inflation is nonetheless showing no sign of acceleration. In March, the core-CPI index even moderated slightly, at +2% year-on-year (the PCE index, which is the Fed’s benchmark, is a shade below). The price of goods moved onto an uptrend in 2018, exiting deflation for the first time since 2013. But these prices are significantly affected by global trends. In particular, they replicate with a certain lag price movements in China, a source of a significant share of production. In light of the trends observed in China in 2018, the price of goods (excl. energy) should stabilise in 2019 in the US (chart rhs). Regarding the price of services, the acceleration of wages presents an upward risk that warrants monitoring, although the risk is taking longer than expected to materialise. Furthermore, a rise in wages can also result in an increase in productivity or a decline in margins. All told, the outlook for inflation in the coming months is unlikely to reassure the Fed. The central bank is increasingly less prepared to accept the underperformance of inflation vs its target rate. The bar for resuming interest-rate hikes is therefore very high and probably cannot be passed this year.
Chief Economist – Oddo BHF AM
Economist – Oddo BHF AM