Economy in Brief: September 2023

The U.K. inflation reported in August paints a familiar picture of the trend for inflation. The CPIH measure rose by 0.4% after falling by 0.1% in July. The core measure excluding food, energy, alcohol, and tobacco was flat in August after rising 0.5% in July. Among the ten major headlines reported for U.K. inflation, the price level change accelerated in only four of them in August compared to July.

Sequential inflation Sequential inflation in the U.K. as measured by the headline rose by 6.3% over 12 months, decelerated to a 4.6% annual rate over 6 months, and decelerated further to a 2% annual rate over 3 months. For the core rate, inflation rose 5.9% over 12 months, accelerated to a 6.2% annual rate over 6 months, and then fell sharply to a 3.2% annual rate over 3 months.

The odd tale of core inflation The tracking of the core inflation rate by 3-month, 6-month, and 12-month calculations is presented in the chart at the top of this report, and it's clear that the 3-month inflation rate, even for the core, has broken sharply lower. For the 6-month rate, there is a more complicated bump-up in inflation before it begins to decline, leaving the 6-month increase slightly higher than its pace over 12 months. The 3-month inflation rate traces out a strange path in which it seems to peak in early-2022 as it proceeds to soften its pace through the end of the year, before spiking to a sharply higher peak rate and then diving sharply and essentially returning the inflation rate for the core back to what had appeared to be the downtrend for the earlier pace of decline before the secondary spike arrived. All of this makes evaluating what's going on in the core much more difficult since the 3-month inflation rate is so different than either the 6-month pace or 12-month pace. Also, because the core has exhibited this extremely rogue behavior, imbuing it with the kind of volatility we normally expect to see in the headline rather than in the core, trusting it becomes more a matter of faith.

The Bank of England The Bank of England must be breathing a sigh of relief, in the wake of these developments. Not only has inflation turned lower but it's done it without having a substantial lift in the unemployment rate. The claimant rate of unemployment, that is more up-to-date, shows that unemployment has moved up to 4% in August from 3.9% in June, not much of an elevation particularly given the deceleration that has occurred in the inflation rate. The headline inflation rate has turned very sharply lower, and the core rate has turned low. The sequential rates of growth, however, are not the whole story. The core rate hasn't moved as much if we simply look at the performance of the year-over-year pace. But the performance in the core over 3 months and 6 months suggests that there's going to be more deceleration in the 12-month pace in the months ahead.

Inflation diffusion The diffusion data that look at the inflation acceleration in one period compared to the previous period show that a year ago the 12-month pace was accelerating in all categories compared to 12-months earlier. Currently the 12-month pace compared to a year ago is accelerating modestly with the diffusion calculation of 54.5; for diffusion the neutral reading is 50%. At that reading, the proportion of categories with inflation accelerating and decelerating is balanced. Over six months, diffusion declines to a 45.5% level; over 3 months, it falls extremely sharply to a 9.1% level. Over 3 months, inflation accelerates only in one category. And that's comparing the 3-month rate to the 6-month rate that already has declined; the acceleration for inflation over 3 months is only from the category ‘education’ where the annualized rate for inflation ‘picks up’ to 3.7% from 3.6%. These are quite impressive trends for the U.K. if the trends have staying power.

Inflation in the European monetary area continue to be strong with August rising by 0.6% month-to-month after rising 0.4% in July and 0.2% in June. The closely watched core measure turned weaker in August rising by 0.3% after a 0.5% gain in both June and July.

Monthly inflation basics Among the four largest euro area members, all but Spain showed inflation increases month-to-month. Posting a 1.4% increase in its July HICP, August brought a much lower 0.7% increase. And what was a significant month-to-month deceleration for Spain was also the second largest monthly headline gain among the Big Four economies. Core inflation for the four largest economies accelerated in only two of the four largest economies. Germany showed inflation excluding energy rising to 0.4% in August after a 0.2% gain in July; Italy's core crept up by 0.1% after being flat in July. The core inflation rate in France edged up 0.1% month-to-month after a 0.5% gain in July, while Spain’s core rose by 0.4% in August after rising a sharp 1.1% in July. Spain’s 0.4% core gain was a deceleration and also tied for the strongest month-to-month core gain across the Big Four economies in August. Comparisons always are complicated when you look for context.

Trends in general When cast in terms of annualized inflation trends – 12-months to 6-months to 3-months- the trends were substantially mixed with negative results over three months. Inflation decelerations were broadly posted over 6 months compared to 12-months and for 12-month inflation rates compared to their values of 12-months ago. Headline inflation over 12 months broadly decelerates compared to 12-months ago while core inflation broadly accelerates.

Headline vs. core trends-acceleration/deceleration Headline inflation in August rises 5.3% over 12 months. That decelerates to a 3.3% pace over six months then ramps up to a 5.2% pace over three months. The 3-month pace is sharply higher than the 6-month pace; and the 3-month pace is only a tick weaker than the year-over-year gain. Core inflation in the EMU is up by 5.4% over 12 months then decelerates to a 4.8% pace over 6 months. Over 3 month inflation comes back to life with the EMU core rising by 5% annualized, on balance a speed-up over 6 months and a moderate slowing by less than one-half of one percentage point comparing the 3-month pace to the 12-month pace.

Sequential trends Looking at these same trends for headline inflation sequentially, all headlines show slower gains over 12-months compared to 12-months ago and another slowdown follows over 6 months compared to 12-months. But over 3 months headline inflation accelerates in all Big Four economies with two of them showing faster inflation over 3 months than over 12 months annualized. Inflation over 3 months accelerates compared to 12-months in Germany and Spain while it decelerates in France (by one-half of one percentage point) and in Italy where the inflation rate is nearly halved over 3 months compared to 12-months.

Core inflation sequentially Core inflation is more interesting from a trend standpoint. It shows year-on-year accelerations in three of four of the largest EMU economies compared to its 12-month pace of 12-months ago. Only Spain shows less pressure over 12 months. Over six months core inflation pressures drop broadly across each of the Big Four economies and by significant amounts. But over 3 months inflation accelerates in two countries and decelerates in the other two. Inflation surges to a 7.9% annual rate in Spain over three months, topping both its 6-month and 12-month pace. In Germany, ex-energy inflation picks up from 3.6% over six months to 3.9% over three months and still shows a two-percentage point back down from its year-on-year pace.

Oil continues to be a disinflation factor The bottom of the table chronicles the performance of oil prices showing Brent is still favorable monthly falling in both July and August -as well as declining on balance over 12 months, 6 months and 3 months.

Inflation evaluation-strange brew The table shows still unacceptable inflation levels and less than reassuring trends across the largest EMU economies as well as for the weighted-average impact of all member countries on EMU itself. With an inflation objective of about 2%, the ECB finds the five-year headline gain (compounded pace) at 3.6% compared to 2.6% for the core rate. Headline inflation over five years for the Big Four range from a high of 4% in Germany to a low of 3.1% in Spain – had I tried to tell you ten-year years ago that would happen, you never would have believed me! And this is for inflation over five years – not a monthly quirk. Core inflation over five years averages the highest among the four largest EMU economies in Germany at 3.2% and the lowest in Italy at 2.3%.

Canadian housing starts have been in a pattern of saw-tooth declines from their 2021 peak. However, starts, viewed broadly, in a longer-term framework, are still quite firm. Starts are higher than their August 2023 level in only twenty-three of the last thirty-seven months, on data back to August 2020. Yet, the August 2023 reading is higher than nearly all monthly results prior to August 2020 (only seven exceptions on data back to January 1990 - 367 observations before August 2020). As a result, I view weakness in housing as limited and recent.

In Canada, housing is not weak and is holding up well. This is despite a 5-year mortgage rate of 5.99% in July, up from rates at or below 3.3% from January 2021 through September 2021. On data from January 2021, Canadian 5-year mortgage rates average 4.12% Their current 5.99% level in July is significantly higher. But interest rates and inflation rates move together and inflation rates are now moderating.

Canada’s 5-year mortgage rate is at 5.99%; historically it has been even higher from May 2006 through December 2008, more or less consistently. From January 1990 through December 2003, it also was above 5.99%. The current mortgage rate is high relative most recent historic experiences but not so much in a broad historic context. Still, mortgage rates moved up above their average since January 2012 (4.12%) as of April 2022 and rates have been elevated ever since. The five-year mortgage rate is currently on its cycle high, but it is only higher by 11 basis points from its level of eight months ago. The momentum for rising rates has dissipated.

The period of interest rate shock would seem to be over for the housing market. Canadian house prices have fallen year-over-year for only four-months in a row (April 2023- July 2023). On data back to 2000, housing prices in Canada rose by double digits only from June 2006 to January 2007… until during the Covid period, when prices rose by double digits from April 2021 through May 2022. House prices in July 2023 in Canada are still stronger than April, May and July of 2023 and are lower only than a string of months from April 2022 to March 2023.