UK Output Prices Lose Momentum - Is It All Good News or Not?

PPI Progress - UK PPI output prices continue to run hot but in the UK but they are losing some momentum. The 12-mo pace of 5.7% is dropping and the shorter sequential growth rates show that PPI momentum has been damped. Better still is that the the MFG PPI Core has been reduced from an annual rate of 4.3% Yr/Yr to 2.4% over 6-mos to 1.7% over three months.

Does moderating inflation tip off a weakening economy in the UK - As inflation news goes this is a fairly rapid downward shift. It is progress and on the face of it, it is good news. But it is also occurring in the context of weak growth in Europe and in the UK. One fly in the ointment is that fast fading inflation can also be a litmus test for weakening economic activity. If activity is falling off fast you would expect to see that play out in the inflation rates. That may be another part of what is going on in the UK where inflation has remained over target for a long while as money supply growth has gone from boom to bust, another transition that often is a tip-off for the onset of recession.

Inflation progress, but... For the moment the inflation news in the UK is good and it is improved. Of course the HICP and RPIX are preferred inflation barometers in the UK and they remain sticky and too high.

Back...but to business as usual - Also for the moment there a bit less pessimism on Europe as Italy appears to be pushing though reforms and the process is supposed to be legislatively complete by the weekend culminating with Berlusconi stepping down and the formation of a unity government. Greece now has a new Prime Minister and Europe hopes that it is back to normal business albeit with the some huge hurdles ahead in implementing what is being agreed to. Stabilizing Europe will be important for the outlook in the UK.

Pop no Champaign corks for Europe - Still, I remain concerned and urge no premature celebration. There is a daunting task ahead of Greece, Portugal and Spain, countries that have lost massive amounts of competitiveness to other countries in the Euro-Area. Italy also is at a severe competitive disadvantage. True Italy has a mostly maintained a primary budget surplus (surplus excluding interest payments), but it has a long way to go to restore lost price competitiveness. The UK, Spain, Portugal and Greece all have run 12- straight years of current account deficits. Yes, the UK has had its own competiveness problems even with its own currency as a policy tool. Italy has current account deficits in 11 of 12 years. These are countries that need to restore their place in a competitive European framework – and that will not be easy

What lies ahead for much of Europe is deflation; be clear about that - To restore competiveness with a still–intact euro means that these out-of-shape euro-imprisoned nations must have what is being called an ‘internal devaluation.’ Compare that to breaking out of the euro, adopting their own currencies and having real depreciations. Let’s be clear on this and what it really means. An ‘internal devaluation’ is just a nicer phrase for ‘deflation’. These countries will have to run deflationary policies. And Japan has found that debilitating. The US is pulling out all-the-stops, trying like heck to avoid deflation, as Fed chairman Bernanke is worried about its consequences. Yet in Europe it is being adopted-or seemingly so- as the policy preferred to a break-up of the Zone itself. Is it really? Deflation actually is the only solution for these uncompetitive countries that stay in the Euro-Area. Do they really recognize that? Do the people recognize that? Has everyone signed on for the consequences? How can they run deflationary policies and still create enough growth to grow their way out of their budget problems? The chosen path may not be an oxymoron but it comes darn close to one (deflation remedy!?). Can those two words co-exist in the same sentence? We will see.

Tough work lies ahead - Success for the Zone in its attempt to push this wounded Zone-beast forward is going to be a real uphill battle. It is a multiyear project which will put an extreme adjustment burden on exactly those countries that have been so unwilling to bear budgets of prudence let alone multi-year austerity. Europe may have dodged a bullet for now but there will be a ricochet when the people experience and unrelenting wall of pain. The UK will have to be wary since what happens to this Zone, a major trading partner for the UK, is very important to the outlook for UK growth itself. Despite all the backslapping this weekend the tough work is just beginning and it will become oppressive. Is Europe really ready?