As a result of the recent decline in oil prices, US inflation is expected to slow significantly in the short term, with a low point in the region of 1.5% year-overyear in Q1. It will likely spend most of 2019 below the 2% threshold. In these conditions, the Fed can afford to suspend policy rate hikes. But beyond oil, we must consider other prices. Their trend is solid and, unless the economy suddenly stalls, it could even accelerate. That is why it seems premature to us to conclude that the Fed has concluded its monetary tightening cycle. It could resume interest rate hikes later in 2019.
Looking at the inflation outlook almost always means putting oil on one side and everything else on the other. Oil is a volatile component based on the world market. The rest reflects more (not only) domestic conditions. At its current level, the WTI price is 33% below its peak in 2018 and 20% below the 2018 average. This situation creates a base effect that is likely to significantly reduce the annual rate of inflation in the coming months. It could fall to around 1.5% in January, while it was flirting with the 3% mark last summer. Inflation (as defined by the CPI) exceeded the 2% threshold for most of 2018, it will likely fall below this level for most of 2019 (chart lhs). Many Fed officials have put forward the likely decline in inflation as a reason to stop rate hikes for at least a few months.
Even so, there has been no decline in inflation expectations or in the other components of the price index. According to the New York Fed, households expect inflation to reach 3%, vs 2.7% in 2017. According to the Atlanta Fed, companies expect unit labour costs to rise by 2.3%, vs 2% in 2017. This is in line with the acceleration in wages in recent months. The underlying index of service prices (which excludes partly “administered” prices such as healthcare and transport) has been on a trend of more than 3% since 2015. The underlying index of goods prices (i.e. excluding gasoline and food) has just returned to positive territory for the first time in six years (chart rhs). There are two reasons for this. On the one hand, the downward pressure on industrial prices has eased at the global level in response to efforts to reduce overcapacity in China. On the other hand, the increase in customs duties is spreading along value chains. Without this, inflation would have been 0.3pt lower in 2018 In short, unless the labour market and domestic demand really weaken, it is difficult to envisage a lasting decline in US inflation.
Bruno Cavalier – Chief Economist
Fabien Bossy – Economist