1 May 2015
Eurozone aggregate core inflation is forming a bottom – Goldman Sachs
FXStreet (Barcelona) - Accelerating inflation in core countries and stabilising inflation in the periphery signals that the aggregate eurozone core inflation might be forming a bottom, as noted by Goldman Sachs.
Key Quotes
“According to the inflation forward curve, headline CPI will not touch 2% again until 2030. In related empirical work, Huw Pill, Pierre Vernet and Mariano Cena have shown that, following the launch of QE, the market-implied probability of Euro area inflation remaining below 1.5% over the coming years has decreased. But it is unclear how much of this is due to the pick-up in energy prices that has occurred over the same period.”
“Indeed, a similar shift in the probability distribution can be seen in the US. Furthermore, the market still assigns little probability to inflation going back above target, even in the long run.”
“We disagree with this pessimistic outlook. Our forecasts suggest aggregate core inflation is already forming a bottom. The latter is the combination of accelerating inflation in the ‘core’ countries, and a stabilisation in inflation in the periphery. Based on this, we think the skew in the inflation market is too pronounced, and that the nominal curve is too flat relative to fundamental underpinnings.”
“Admittedly, given Japan’s experience of trying to revive inflation amid deleveraging and structural bottlenecks, our inflation forecasts may need to be realised before the market turns in a more sustained way.”
“But from current levels, the risk-reward appears to us skewed towards higher Euro area long rates, particularly when we account for an acceleration in foreign growth and the start of a tightening cycle in the US later this year.”
Key Quotes
“According to the inflation forward curve, headline CPI will not touch 2% again until 2030. In related empirical work, Huw Pill, Pierre Vernet and Mariano Cena have shown that, following the launch of QE, the market-implied probability of Euro area inflation remaining below 1.5% over the coming years has decreased. But it is unclear how much of this is due to the pick-up in energy prices that has occurred over the same period.”
“Indeed, a similar shift in the probability distribution can be seen in the US. Furthermore, the market still assigns little probability to inflation going back above target, even in the long run.”
“We disagree with this pessimistic outlook. Our forecasts suggest aggregate core inflation is already forming a bottom. The latter is the combination of accelerating inflation in the ‘core’ countries, and a stabilisation in inflation in the periphery. Based on this, we think the skew in the inflation market is too pronounced, and that the nominal curve is too flat relative to fundamental underpinnings.”
“Admittedly, given Japan’s experience of trying to revive inflation amid deleveraging and structural bottlenecks, our inflation forecasts may need to be realised before the market turns in a more sustained way.”
“But from current levels, the risk-reward appears to us skewed towards higher Euro area long rates, particularly when we account for an acceleration in foreign growth and the start of a tightening cycle in the US later this year.”