Fathom Newsletters

Next week's dataflow will be heavy, but aside from the Bank of England's latest quarterly Inflation Report and an expected contraction in euro area GDP, it is likely to be dominated by inflation data. France, Germany, Italy, the UK and US all release first estimates or details of their July readings. We have therefore updated our medium-term inflation forecasts for the UK, US and the EA. As ever, we provide a central projection based where possible on market pricing for variables like oil futures, and a range around that forecast. Hence we show both the central projection or most likely outcome, and  90% confidence bands. In addition, in the case of the UK, we also provide a matrix based on a range of possible outcomes for key variables like house prices; interest rates; energy prices; and crude oil prices.

The attached presentation summarises our key findings, but we would highlight the following points:

• According to the benchmark, inflation should peak in the US, EA and UK within 1-2 months. Specifically, CPI inflation should peak at 5.1% in the US in July, 4.2% in the EA in August and 5.0% in the UK in August.
• Thereafter, inflation falls sharply in all three economies in the benchmark projection. But it should fall much more quickly in the US and the UK than in the EA. Empirically, inflation is more persistent in the EA, probably because price increases there are much more likely to have second round effects in terms of higher wages.
• Looking at the width of the fan charts, inflation is less certain in the US than elsewhere. That is because changes in oil prices have a much larger impact on US CPI owing to the comparatively small tax element.
• We find around a 10% chance that EA inflation drops below the 2% target by the end of next year. By contrast, the chance that UK inflation drops below 2% by the end of next year is around 65%
• If UK rates fall to 4% during 2009, our RPI forecast falls to 1.2% by the end of the year. If rates were to fall to 3.5%, RPI inflation would be below 1%
• We find around a 15% chance that the US is in deflation in one year’s time. That would require a fall in the oil price to somewhere around $80.