Great Graphic: Euro Area and US Consumer Prices

There is much talk of an ECB rate cut on Thursday. Many economists have forecast a cut after a disappointing series of German data last week. Even if the German economy did not contract in Q1 after contracting in Q4, it is off to a poor start in Q2. 

The case for an ECB rate cut, which we think the odds are greater for a June move than this week, is not simply predicated on weaker growth. The case is also based on moderating price pressures. CPI appears to have fallen to 1.2% in April from 1.7% in March. The Bloomberg consensus was for a 1.6% increase.

This Great Graphic, which we created on Bloomberg, shows euro area inflation and US inflation. The pace of increase in the US CPI has also slowed markedly. Although the basket and weightings are different, euro area and US CPI track each other fairly well. The big divergence took place in late 2009, which corrected by the middle of 2010. Since mid-2011, US CPI has fallen faster than euro area inflation, but with this April report, the euro area is back "ahead". 

The pace of decline in the US may ease as the base effect for the US is unfavorable. From April through July 2012, US monthly CPI prints were flat to slightly lower except for June's 0.1% increase. The drop in gasoline prices (especially on seasonally adjusted basis) may exert some downside pressure on headline rates, which may be blunted by non-energy increases.  Later in the Q3, when the 0.5% rise reported in both Aug and Sept drop out, more substantial pressure will likely be seen in the US year-over-year rate.  

We suspect that expectations around QE are obscuring the decline in measured inflation in the US.  Yet it is likely to increasingly draw the Fed's attention.  The Fed puts more weight on the core PCE deflator.  Yesterday's report for March showed a 1.1% year-over-year rate.   The combination of weaker growth and easier price pressures (even if the US is not targeting nominal GDP formally) is a major argument against those at the Fed,  who last month were talking about wanting to taper off purchases around mid-year.