PPI Is Still High But Is Pressure Deflating?

Central bankers like Yr/Yr inflation trends because those trends usually are ‘true’. In the case of the Euro-Area’s PPI, Yr/Yr inflation is still pretty high and the sector paths show very little loss in near term momentum except for intermediate goods.

Over the short time horizon, there is a little more in the way of hopeful trends on inflation. We know that globally commodity prices have come down as global growth has weakened from the US to Europe to China. That should naturally feed its way into and flow though intermediate goods prices. We are seeing exactly that happening as intermediate goods prices are lower at a 0.9% pace over three months. Headline ex construction-prices are falling rapidly, too.

German, UK and Italian PPI prices (Core prices for Germany) are decelerating over three-months compared to six-months and over six-months compared to twelve months. This will be encouraging news to the ECB and the BOE.

The Euro-Area PMI economic activity indices showed a widespread weakening in the Zone in MFG and services surveys in August, in key reports released just yesterday. Even though Trichet has made the argument that he would not sacrifice price discipline, it seems clear that he is not being forced to make that choice.

The time for tough talk is really over. Trichet may continue on that path for a while because he wants his intentions clear even as inflation lingers over the top of the ECB ceiling. It is reasonable at this point, in this weakened environment, to let inflation come back down by itself instead of actively pushing it back down.

ECB policy now seems to have acquired more clarity and predictability, although its maneuvering in the lingering European debt crisis is still enigmatic. Fed policy is not yet clear. The latest US employment report raises as all sorts of questions about what policy changes the President will announce, what can be passed by Congress and what the Fed will do. On top of that there is a real problem with the outlook itself which is looking bleaker by the day. Still, we cannot really tell how weak it is going to become.

Policymakers are standing at a cross roads. But their GPS is not working. They know that they have momentous decisions to make but they just can’t bring themselves to make them. They know that by making no decision they are losing time and getting behind as things get worse. Still, we are stuck at the cross roads paralyzed by counterpunching political factions. Europe has intra-EMU rivalries; in the US it’s traditional Republican-Democrat conflict.

At least inflation is losing some steam and taking central bankers off the path to do the really tough thing: to raise interest rates while the economy is weakening. The BOE already has been tolerating inflation way over the top of its ceiling amid economic weakness; Trichet has made it clear he would not do that. But the ECB has, because of politicking and events, been taken off that path. That is the main reason that Trichet keeps the rhetoric of inflation fighting turned up; its because the policy itself has been turned down. The Fed has flirted with and encouraged rising inflation but that seems to be fading and the Fed may, once again, sound the alarm against inflation’s even more evil twin, deflation.

Some things never seem to change no matter how much money you throw at the problem. Had the little Dutch boy shoved a wad of $50 bills in the hole in the dike (...okay a wad of 50 guilder notes...) that may have been a lot of money but it still would only have been a temporary solution. Our central bankers may find that money is not the solution to all the problems they are trying to fend off as well. Monetary policy might buy time or then maybe it will only rent it, but there is a really fine distinction with no practical meaning to that choice. The time gained will only be temporary and fiscal authorities will have to use it wisely if Europe and the US are to get across to the right branch of the cross road each faces. Can they do it? Inflation is giving them a breather but growth is turning up the heat.