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Economy in Brief

CPI Soars as EMU Sentiment Tubes: Price Relief is Minor
by Robert Brusca September 30, 2008

Headline is turning sharply in a favorable direction; core remains high and ‘sticky’

In one of my favorite comedy skits of all times Dan Aykroyd of the US TV show “Saturday Night Live” was imitating Jimmy Carter at the height of the US inflation bubble. He launched his ‘inflation is your friend’ skit urging people (while imitating Carter) to enjoy wearing $1,000 suits and living in million dollar houses and smoking $100 cigars. It was a great skit. But the view does not reflect the realities of policy.

Since those days central banks have made it a real business of stamping out inflation. But when oil prices spurt it is hard to keep a lid on inflation. Oil is just too important and people do not substitute away from it with enough vigor to damp its impact on overall prices. Central banks that target headline inflation or pose ceilings for it, have had their heads handed to them.

In the US the Fed has been criticized for its focus on CORE inflation (since people live in a headline inflation world) but, in the event, core inflation has been much more on track with the Fed’s professed comfort zone (not a formal target). And that eventually builds credibility.

In Europe the core rate is at 2.3% over three months and six months (lagged since we do not have the core yet for September) it is in improving shape even as it is at 2.6% Yr/Yr. That’s still a percentage point better than (up-to-date) headline inflation. Had Europe focused on this rate it would regard inflation as closer to the target. Instead, while headline inflation is decelerating (0.7% annual rate over three months) it is still running at a tortuous 3.6% Yr/Yr pace that is light years away from a 2% ceiling, tying the hands of the central bank.

I am not suggesting a shift to an ‘inflation is your friend’ monetary policy. But in targeting headline inflation the ECB has boxed itself in. It is not able to be preemptive and will only be able to cut rates once economic weakness is clearly in train and that will make the hammer of economic downturn hit harder.

When this is all over the ECB would do well to reconsider what it targets. As a general rule it makes no sense to target something you cannot hit or will not hit. And a headline inflation rate of 2% ‘MAX’ with oil prices moving as they have is something no central bank in the world would try to hit. Europe needs to do some re-thinking to avoid a policy re-stinking.

Trends in EMU HICP; Flash Index
  % mo/mo % saar
  Sep-08 Aug-08 Jul-08 3-Mo 6-Mo 12-Mo Yr Ago
EMU-13 0.1% -0.1% 0.2% 0.7% 2.4% 3.6% 2.1%
Core #N/A 0.3% 0.1% 2.3% 2.3% 2.6% 2.0%
Goods #N/A -0.4% -0.9% -3.4% 4.0% 4.6% 1.2%
Services #N/A 0.3% 0.9% 6.0% 4.3% 2.7% 2.6%
Germany 0.2% -0.2% 0.4% 1.5% 2.1% 3.0% 2.6%
France #N/A -0.2% 0.1% 1.4% 3.0% 3.5% 1.3%
Italy -0.2% 0.4% -0.1% 0.4% 2.2% 3.7% 1.8%
UK #N/A 0.5% 0.4% #N/A #N/A #N/A 1.7%
Spain #N/A -0.1% 0.4% 3.5% 3.8% 5.0% 2.2%
Germany #N/A 0.3% 0.3% 2.7% 1.7% 1.9% 2.3%
Italy #N/A 0.7% -0.2% 3.4% 3.2% 3.2% 2.0%
UK #N/A #N/A 0.3% #N/A #N/A #N/A 1.8%
Spain #N/A 0.3% 0.3% 3.8% 3.0% 3.5% 2.6%
Blue shaded area data trail by one month.
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