INFLATION / THE FINANCIAL TIMES LEX

Inflation


Published: August 27 2009 15:04

Why it is investors react to so-called headline numbers is one of the many mysteries of finance. From company results to retail sales figures, the truth hidden in the detail is often ignored. The public care even less for subtleties. With inflation, for example, efforts are made to present the data in a variety of different ways – by stripping out volatile components such as food and energy prices. However, it is the headline numbers that always make the news.

And because headline inflation affects expectations, a close eye should be kept on the last few months of this year. Year-on-year comparisons will be strongly affected then by the plunge in energy prices at the tail end of last year. In the US, for example, the seasonally adjusted consumer price index fell 2.4 per cent in July. Other things being equal, and adjusting for the small change of the weighting of the energy component in the index, headline inflation will start to rise on a year-on-year basis in November, and then peak at 1.6 per cent in January.

Of course energy prices, as well as the other components of the inflation basket, are unlikely to stay flat. But the exercise shows there is a risk that the public – not to mention investors and central bankers – could shift from a fairly neutral view on prices to worrying about inflation again. It is unlikely that policy makers would be fooled into raising interest rates – although the European Central Bank did foolishly tighten as late as July last year, citing the need to anchor inflation expectations. Yet fixed income markets could react, pushing borrowing costs higher. The struggling world economy hardly needs that. The good news is inflation may appear to fall again as the latest rally in energy prices affects comparisons the other way round. But even that effect will not last if energy prices continue upwards. Already, in August, German inflation has jumped ahead. Expect inflation on a year-on-year basis to rise elsewhere also – at least for the next few months.