Economy in Brief: October 2022

The UK inflation metric for September continues to run hot. The CPIH has increased by 0.4% in September after rising by 0.3% in August and 0.7% in July. Its three-month rate of growth is at 5.7%, clearly excessive, relative to the 2% target of the Bank of England, however, there is substantial deceleration from the 6-month annualized pace of 9.4%; the 3-Mo pace also is weaker than the 8.8% pace over 12-months. Still, one year ago this month this measure was increasing at a 2.9% annual rate also above target but this month’s year-over-year gain of 8.8% as well as its lower 3-month pace exceeds the year-over-year pace from a year ago.

The same measure excluding food alcohol and tobacco (that I will refer to as the core) increased by 0.4% in September after rising 0.5% in August and 0.4% in July. This measure runs at a 5.6% annual rate over three months and has accelerated compared to 6-months where the rate was 5.2% annualized. The 5.6% pace compares to a 12-month pace of 5.8%, barely any deceleration at all.

Core shows mixed results: the 6- and 6-Mo pace are off peak; 12-Mo still accelerating All the acceleration in the UK CPI measure over three months is in the core reflecting a diminished rose for energy and food prices; core inflation continues to run hot and shows no real sign of deceleration as it runs at a rather steady too-strong pace.

The diffusion calculation which measures the breadth of inflation across 10 categories plus the core measure shows diffusion at 45.5 in September. For diffusion, the key value is ‘50.’ Above 50 more than half of the components are showing inflation acceleration period to period. Whereas, below 50, more of them are showing deceleration. These measures are comparing the breadth of inflation’s rise or fall in one period to another period. In August, inflation accelerated with diffusion at 54.5 indicating marginally more acceleration than deceleration for the inflation rate. But then in July, despite a headline gain of 0.7%, and a core gain of 0.4%, the month-to-month diffusion measure clocked 27.3 indicating a broad step down in inflation compared to the month before (when the headline rose 0.8% and the core by 0.7% month-to-month).

Sequential data show diffusion at 63.6 over 3-months compared to 6-months. The 6-month measure shows diffusion at 54.5 compared to its 12-month pace. Over 12-months diffusion is at 100 indicating acceleration in inflation across all the categories compared to the inflation rate of 12-months earlier.

The sequential numbers show us that inflation is not simply the matter of one or two categories that are accelerating because the breadth of inflation is clearly across most categories and is not the result of some intense increases in just a few categories with large weights that are driving the headline higher. This is the sort of information that diffusion can deliver to us.

**The United Kingdom continues to have inflation problems **with strong inflation represented in the headline pace and the core pace and across all the sequential time horizons. UK inflation trends muddles without a clear-cut patterns and with the pace of inflation, however measured, simply far too high. The inflation news may not be terrible and may not be a lot worse this month than last month...but it’s not any better either. At the same time the economy is facing weaker growth; that combination of events puts the Bank of England in a difficult spot. UK policy is in an extremely challenging situation. The government's intended fiscal plan has been forced to be withdrawn after it had adverse market effects. But the central bank will certainly stay on a tightening path but will be able to move in a more measured pace because of the encroaching weakness of the economy and some of the financial market jitters that have emerged.

The Zew economic indicators for the macro economy for the Euro-Area, for Germany, and for the US decline significantly in October. The Euro-Area diffusion reading fell from -58.9 in September to an October reading of -70.6. In Germany, the diffusion index deteriorated to -72.2 in October from -60.5 in September. And the US deterioration was from a +1.2 reading for September to -13.4 in October. These are substantial deteriorations. They have left the Euro-Area with a queue standing in it's 18.9th percentile, Germany in its 19.1 percentile, and the US and its 31.4 percentile. These are reading that have been lower only one third to one-fifth of the time (The US has the less weak standing).

Economic expectations for Germany and the US showed mixed trends. For Germany, the macroeconomic expectation reading improved very slightly to -59.2 in October from -61.9 in September. This reading still leaves it below the August-22 level. And the US the macroeconomic outlook deteriorated to 45.6 in October from 39.6 in September. Both the German and the US queue standings post October readings that are extremely weak. The German reading has been this weak or weaker 1.4% of the time; the US reading has been this week or week or 5.7% of the time – not much difference.

Inflation expectations that had revived a little bit in September have been sharply reduced in October as their trend decline continues. The Euro-area inflation expectations reading fell to a -35.8 diffusion index reading in October from -12.1 in September; in Germany inflation expectations fell to -35.2 in October from -9.7 in September. In the US inflation expectations fell to minus -71.0 in October from -50 in September. The Zew financial experts are coming to fear inflation less as they come to recognize weaker macroeconomic conditions and as they continue to hold extremely weak expectations for future growth. Inflation expectations have been reduced to a 4.4 percentile standing in the Euro-Area, to a 14.8 percentile standing in Germany and to a new all-time series low in the US. This does not mean inflation is going away; but it means the assessment is that there is a high probability that inflation has peaked. At some point diminished economic activity and poor expectations for the future must result in less inflation pressure.

However, on the interest rate front for the Euro-Area we see a diffusion reading of 92.6 in October compared to 93.3 in September it's a small reduction that probably doesn't really mean anything because the readings are still so high- in the 90th percentile. Clearly the Zew experts continue to see the ECB raising rates. And in the US also there's a slight diminution of pressures in short term rates as the October diffusion index falls to 87.3 from 89.7 in September. That's another very modest and not noteworthy change in expectations. And the case of the Euro-Area, that diffusion reading is in its 98.9th percentile. For the US, the reading is in its 91st percentile. In both cases expectations for higher short-term rates are extremely strong. And that is more the point than that there was some very modest backing off.

Moving on to long-term rates, we see pressure coming off long term rates expected in both Germany and in the US. In October, the German diffusion index falls to 48.7 from 55.2 in September. In the US, the reading falls to 40.6 in October from 50.7 in September. The lower diffusion readings imply less pressure on long term interest rates. In Germany, the standing of that diffusion index is in its 60.9 queue percentile, showing that expectations for long rate increases are above their historic median ( the median occurs that at a queue standing at the 50th percentile). In the US, the queue standing is at its 41st percentile, below its historic median.

Stock market expectations have improved slightly for the Euro-Area area and in Germany; they are marginally weaker in the US. In the Euro-Area stock market expectations flip from a - 5.2 reading in September to a + 2.5 reading in October. Similarly, in Germany, the October reading flipped to a +1.2 reading from a -5.9 reading in September. The US the October diffusion reading edged down to 11.7 from a September reading of 12.5. The Euro-Area and German readings are still both in the lower two percentile of their historic queues of observations for stock market expectations. And in the US the reading is a bottom 25 percentile reading at its 25.7 percentile mark. These are weak queue percentile standings for all three areas; however, the weakest standings are for Germany and the Euro-Area.