MacroScope

India inflation consistently tough to pin down

High inflation is a drag on economic growth in the world’s second most populous country and matters immensely to over 400 million people, or over a third of India’s total population, who struggle to earn enough to feed their families three meals a day.

The particularly volatile nature of inflation in India has confounded policymakers and small business owners and has left economists, who are often running complex statistical models based on a dearth of reliable data, with a poor forecasting record.

To be fair, predicting economic data can be pretty tough in a country where collecting and reporting national statistics is still in its infancy stage. Provisional numbers are often completely revised away.

The latest sharp revisions to historic gross domestic product data, which show that India’s economic performance during the aftermath of the global financial crisis was worse than previously thought, is just one recent example.

Economists have underestimated the pace of monthly wholesale inflation 17 times over the past two years, according to an analysis of Reuters polls.

Inflation no obstacle to more Fed easing

Another reason the Federal Reserve may have additional room for monetary easing: Inflation expectations fell sharply in May, according to the latest Thomson Reuters/University of Michigan survey of consumer sentiment. Inflation expectations five years out dropped to 2.7 percent in May, the lowest since January. Fed officials often say expectations are a key leading indicator of actual price increases.

Daniel Silver, economist at JP Morgan:

This level of longer-term inflation expectations is towards the bottom of the range that has been reported in recent years – 2.7% has been hit on several occasions (most recently between October 2011 and January 2012) and 2.6% was only reached back in December 2008 and March 2009, early on in the crisis period. Most other inflation measures that the Fed watches (including core PCE inflation and the 5yr-5yr breakeven inflation rate) have signaled that inflation expectations are still anchored and underlying inflation pressure is modest.

The downshift comes in the wake of inflation figures for April that also pointed to a tame price environment. This is why Eric Green at TD Securities argues “U.S. inflation favors the doves.”:

QE3 more plausible if inflation expectations keep falling

When it comes to the price stability half of their mandate, Federal Reserve officials have made one thing clear: they will not allow inflation expectations to veer very far from their preferred path. That’s because they believe inflation expectations are a good proxy for the pace of future price increases.

This applies both to the upside, when rising prices are a problem, and when the opposite is true, and policymakers fear deflation. The Fed argues that its second round of quantitative easing or QE2, when it purchased $600 billion in Treasury bonds, averted the risk of such a downward spiral of falling prices and wages, which can take years to overcome.

That’s why the latest figures from the Thomson Reuters/University of Michigan survey of consumer sentiment may strike a chord, particularly with the Fed’s more dovish camp. Inflation expectations one-year out dipped to 3.2 percent from 3.3 percent. Even more strikingly, 5-years out, consumers’ inflation projection fell to 2.7 percent from 2.9 percent. That was the lowest in a year and just 0.1 percentage point above the mid-crisis low of 2.6 percent.

Rip-off Britain in effect

While most of the developed world frets about deflation, in Britain, inflation just won’t quit. 

The Bank of England has been forecasting a sharp fall in consumer price inflation for about as long as Britons have hoped for a summer of uninterrupted sunshine. But at least Britons are still betting on a fair amount of rain. 

UK inflation was 3.2 percent in June, a slight fall from the month before, but still 1.2 percentage points above the central bank’s target rate

Watch price of booze for inflation tips, says Cleveland Fed

What do the price of infants’ clothing and alcohol have in common? They are “sticky prices” that rarely change.

Federal Reserve researchers Michael Bryan and Brent Meyer say these sticky prices may be a better indicator for where inflation is heading.

“While a sticky price may not be as responsive to economic conditions as a flexible price, it may do a better job of incorporating inflation expectations. Since price setters understand that it will be costly to change prices, they will want their price decisions to account for inflation over the periods between their infrequent price changes,” the researchers wrote in a study published on the Cleveland Fed’s website.

The Big Five: themes for the week ahead

Five things to think about this week:

BOND YIELDS 
- Nominal bond yields have risen across the curve, while term premiums and fixed income volatility are higher in an environment of uncertainty about how central banks will exit from quantitative easing policies once recovery takes hold. Bonds have turned into the worst-performing asset class this year according to Citi and none of the factors which markets have blamed for this are about to disappear. Curve steepening seen in April/May has started to reverse and whether it continues is being viewed as a more open question than whether yields head higher still.

RATTLING EQUITIES? 
- World stocks’ are struggling to extend the near-50 percent gains seen since March 9 but they have yet to succumb to gravity despite a back up in government bond yields. Citigroup analysts reckon global equity markets can rally as long as Treasury yields stay below 5-6 percent but it might be the speed of yield moves that determines whether equities get rattled or keep looking past higher borrowing costs to the recovery story. 

INFLATION EXPECTATIONS 
-  Increases in the prices of oil and other commodities have seen the CRB index rise about 30 percent in less than four months and sustained gains will risk filtering through to prices and price expectations. Inflation reports are due out on both sides of the Atlantic next week but markets are looking further out and starting to price in the risks of a pick up in price pressures. Breakevens have turned positive all along the U.S. yield curve for the first time since autumn and euro zone breakevens have risen. Also, a Bank of England survey indicates public price expectations are up. Bid/cover ratios and tails at inflation-linked bond auctions will tell their own story on extent of demand for inflation hedges.