Central banks around the world have been alarmed at how inflation has plummeted in the last year, in many cases into negative territory. Though much of that is due to oil prices, core inflation, which excludes energy and food, has also been disturbingly low.
But there are tantalizing signs that the cycle has turned. In February, U.S. consumer prices rose 0.2% from January, which pulled the annual inflation rate out of negative territory; it’s now zero. More important, core prices rose 0.16%, which nudged the annual rate up to 1.7% from 1.6%. It was the second upside surprise to core inflation in a row. The driver in January was firmer service prices, this month it was goods.
There have been scattered signs that inflation has bottomed out elsewhere, as well. In the eurozone, the 12-month inflation rate rose from minus 0.6% in January to minus 0.3% in February, while core inflation ticked up ever so slightly to 0.7% from 0.6%. (Britain is an exception: both headline and core inflation came in lower than expected in February.) Anecdotal evidence is also piling up. As my colleague Josh Zumbrun has noted, the Billion Prices Project at the Massachusetts Institute of Technology, which skims the Internet every day for up to date pricing information, is signaling a turn.
To be sure, these are tentative signs. Still, they are consistent with some of the fundamentals as well. The first is oil. It dropped to $46 per barrel in late January and has more or less hung around there. The futures market is pricing oil for delivery a year from now at $56. Oxford Economics projects that inflation using the price index of personal consumption expenditures (the Federal Reserve’s preferred gauge) will reach 1.7% by the end of this year, assuming crude prices rise by $10 per barrel, and core inflation will hit 2%. (It will rise less, if, instead, oil prices drop $10 from here.)
The dollar is more complicated. Its peak impact on U.S. prices probably still lies ahead. But whatever downward pressure it is exerting on U.S. prices is mirrored by upward pressure on eurozone prices. In any case, the dollar, too, seems to have stabilized, so the drag it exerts should soon end.
Finally, the European Central Bank’s initiation of bond-buying (or quantitative easing) has delivered a surprising jolt to market sentiment and bought it, and its peers, some badly needed credibility. In the eurozone, the U.S. and Japan, the bond market’s expected inflation rate five years from now has bounced higher since the ECB’s QE began. At the same time, purchasing managers’ indexes suggest the underlying eurozone economy has also perked up.
It’s obviously premature to declare the low-inflation scare over. Even if headline and core inflation have bottomed, they remain a long way from the 2% level most central banks target. The eurozone’s core inflation rate has been trendless at around 0.7% for the last year. Even if market expectations have moved up, they still price in below-target inflation for years to come. And the most important long-term drivers of prices are wages and labor costs, and those show little sign of a pickup.
But policy makers and investors need to pay close attention to what happens on the margin, and on the margin, inflation’s looking up. Which is a very good thing.
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