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Sharp inflation drops to the delight of consumers
Publication date: 20 June 2012
Author: Simon Denham, Capital Spreads
The last two months has seen inflation fall off a cliff face much to the delight of consumers who’ve been suffering from falling real incomes for too long now and even continue to do so. Wage inflation is still below the rising prices but as long as oil prices remain under pressure then we could see further falls. The declines in crude show just how much affect it has on the rate of inflation and consumers will be hoping that these price drops continue. You would never want them to go too far however and the worst case scenario would be deflation. We nearly suffered from declining prices back in the fallout from the banking crisis but thankfully did not which would have made the recession even deeper than it was. The rate with which prices have fallen in the past couple of months, way more than the BOE had expected, does just raise the prospect that we might in the worst case see inflation fall to below the BOE’s target.
But a fall in crude prices may be good for one economy but it isn’t so good for others. Back in 2008 and 2009 when crude crashed from around $150 a barrel to almost as low as $30, the economies of those countries dependent on high oil prices suffered severely, in particular Russia which saw a booming economy slump into a very deep recession. For them crude prices below $100 a barrel are not a good thing, especially when “new” President Putin is so reliant on oil prices to remain high so he can implement his extensive spending plans. Brent and Nymex crude have been particularly volatile of recent and they remain a good indication of risk appetite.
Interestingly whilst the FTSE and other indices have put on impressive gains so far this month, oil has declined over 6%.
So whilst the FTSE has seen a rise of over 5% so far in June it hasn’t been down to the types of heavyweight mining and energy stocks which really have been very sluggish. This morning the FTSE is just in the red after a strong gain yesterday as investors wait to hear from what central banks have to say. The BOE releases the minutes of its latest interest rate decision and so we will want to hear what they have to say about the recent fall in inflation and the prospects for growth, but in particular whether it’s likely they’ll increase do another round of QE. The major event today however is the FOMC later where expectations are that they will at least extend their operation twist or even go a step further with a round of QE3. If we see neither then the bulls could be very disappointed.
As mentioned this ongoing turmoil in the eurozone crisis may convince the Fed to extend operation twist, selling short term debt and buying long term bonds at its meeting due to start later today. In turn that speculation supported a rally in the Dow Jones yesterday and in the last few days the markets have been entertaining the idea of more stimulus.
Despite some surprise weak figures on the German economic sentiment, the euro rose 113 pips to 1.2688 yesterday in anticipation the Fed will pledge more measures to stimulate the US economy. At the same time a world leaders’ summit in Mexico was also a supportive feature as it promised more coordinated action around the globe to boost growth.
In the face of a lower greenback which usually brings in additional buying power, gold prices lost $9.27 to $1617.50. Somewhat odd for the decline is also the expectation the Fed will announce another round of monetary easing, a bullish feature for the precious metal seen as an alternative asset.
A surge in equity markets coupled with a lower US dollar drove the WTI crude prices 97 cents higher to $84.03. By and large, widespread expectations the Federal Reserve might take actions to spur economic growth was behind it. In the meantime, the weekly inventories statistics will also be in the focus and could offer some extra hints on the next possible direction for the energy complex, but already this morning we are seeing a little risk aversion as Brent dips below $95 at the time of writing.
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