Is Inflation Returning? Inflation Expectations are Rising

Japan reports CPI, alongside retail sales, unemployment and overall household spending early tomorrow in Tokyo.    Despite the extremely aggressive expansionary monetary policy, the BOJ has not managed to squash deflationary forces.  

The BOJ has chosen to target the core rate, which in Japan excludes fresh food.  The BOJ also wants to discount the sales tax increase from last April, which will be soon dropping out of the base effect.  By this measure, Japan's inflation is expected to have been just above zero in February.  The BOJ has warned that CPI may be flat for the next few months.  

The US reported February CPI earlier this week.  The Federal Reserve does not target CPI but the core PCE deflator, which typically runs a little below the core CPI measure.  Still, for the second month in a row, the core CPI bested expectations.  The headline rate increased for the first time in four months.   There are some other anecdotal reports, like MIT's Billion Price Project (real time internet prices), warn of some creeping upside pressure to prices.   Meanwhile, the May gasoline futures contract is up about 24% off the mid-January low and the CRB index is up more than 5% from last week's 6-year low. 

The eurozone reported February consumer prices last week.  The 0.6% increase in the headline rate was the largest since last March.  The core rate ticked up to 0.7%, which is where it was throughout Q4 14 before dipping to 0.6% in January.  Next week Germany and Spain will report preliminary March figures (March 30) ahead of the eurozone preliminary estimate the following day.  We anticipate a small increase in both the headline and core rates. 

One of the reasons official worry about deflation is that it could potentially deter consumption as households anticipate lower prices.  While this seems logical, the evidence for this is poor.  Spain good example of this.  On the EU harmonized basis, Spain has among the deepest bouts of deflation (February -1.2% year-over-year).  It will report February retail sales on March 31.  In December, retail sales were up 5.3% from a year ago and 4.2% in January.   German retail sales rose 2.9% in January (month-over-month) after an upwardly revised 0.6% rise in December (initially 0.2%).  The year-over-year rate stood at 5.3% in January, up from 4.8% in December and the highest since 2010. 

The UK reported its February CPI figures early this week.  The year-over-year rate slipped more than expected, easing from 0.3% to flat.   Weak price increases have not deterred British shoppers.  February retail sales, reported earlier today, rose by nearly twice the consensus expectations.   The 0.7% increase was the largest rise in three months.    The 5.7% year-over-year increase has only been bested a handful of times in over the past decade and all of which were recorded in the last 10 months.  The retail sales deflator fell 3.6% from a year ago, which is the largest decline since time series began in 1996.  

In summary, there are some preliminary signs of somewhat firmer prices in the US and eurozone.  In contrast, prices still seem heavy in the UK and Japan.    Inflation expectations, measured by breakevens (difference between conventional yields and yields on inflation protected securities) are rising.  The 10-year breakeven in the US has risen from about 1.5% in mid-January to 1.6% in mid-March and now are near 1.85%.  The German 10-year breakeven has risen from about 0.5% in early January to about 1.3% in the middle of last week.  It is consolidating near 1.25% now.   The UK 10-year breakeven is at new highs for the year today, just above 2.6%.  In late January, it was near 2.27% and in the middle of last week it was still below 2.35%.   Japan's 10-year breakeven is just above 1.0% now.  It bottomed in mid-January near 70 bp.