Global inflation: off the boil

G7 headline inflation has rolled over decisively, and core inflation should soon peak.

G7 headline inflation tumbled to 1.8% in September, the lowest rate in more than two years. The decline was triggered by the fall in energy prices, which are now 1% below year ago levels, after surging earlier in the year. Energy price inflation will probably not dip much further, so trends in core inflation will drive the headline figure in the months ahead. Signs that global growth will slow through the first-half of next year underpin the view that G7 core inflation should stay contained and could even drift modestly lower.

A more detailed analysis of G7 aggregate  inflation rate increases this year, shows that they largely reflect pressures in the U.S. where core CPI inflation is nearly 3%. Elsewhere in the G7, core inflation is running at a benign 1% year-over-year rate. Prices continue to decline in Japan, and are up just 0.8% in Germany, where the economy has accelerated markedly. The unfolding slowdown in the U.S. has already tempered inflation expectations and readings should gradually fall. In Japan and Europe, ongoing globalization and improvements in labour productivity indicate that core inflation should remain subdued even as the economic expansion rolls on. Bottom line: inflation will stay low in the major economies, ensuring monetary conditions remain supportive of growth and asset markets.

U.K. economic acceleration intact... for now

Decent economic growth in the U.K. will keep the Bank of England hawkish.

The BRC retail sales monitor ticked down on a year-over-year basis in October, suggesting the acceleration phase in U.K. consumer spending may be nearing an end. Nonetheless, retail sales growth will likely remain fairly firm in the near term given the renewed uptrend in house prices. A firm housing market should help bolster weak consumer confidence and encourage activity, which will help offset a sluggish labour market. Against this backdrop, the BoE is likely to remain concerned about inflation pressures and stay hawkish. While a rate hike tomorrow (Thursday) is a virtual certainty, next week’s BoE Inflation Report will provide clues as to the likelihood of any additional tightening. Bottom line: expect the BoE to stay hawkish until the U.K. economy shows signs of decelerating.  

What would US policy gridlock mean for markets? 

With a Republican in the White House and the Democrats controlling at least half of Congress, legislative progress is likely to be much slower since the party of George Bush no longer controls both houses. The result could be gridlock as key Bush initiatives are blocked in the House.

However, looking back since 1921 the Dow Jones Industrial Average has tended to do better during periods of gridlock when the President and Congress are of different stripes as radical legislation tends not to get passed and investors can discount the status quo. Conversely, returns have been lower during periods when the stripes have been the same and government is more potent.

So far the market impact of the election has been limited, but a total Democratic sweep of House majorities might spark a rethink. Issues to consider may be eventual drug price controls, the higher costs of developing energy with an emphasis on renewables, a rolling back of the Bush tax cuts and trade protectectionism. Sectors that may be affected could be health management organisations (HMO's), the oil and gas sector and defence stocks."   

And finally……..the benefits of experience. 

A wealthy old lady decides to go on a photo safari in Africa, taking her faithful aged poodle along for company.

One day the poodle starts chasing butterflies and before long, he discovers that he's lost. Wandering about, he notices a hungry-looking leopard heading rapidly in his direction.

The old poodle thinks, "Oh, oh! I'm in deep doo-doo now!" Noticing some bones on the ground close by, he immediately settles down to chew on the bones with his back to the approaching cat. Just as the leopard is about to leap, the old poodle exclaims loudly, "Boy, that was one delicious leopard! I wonder if there are any more around here?"

Hearing this, the young leopard halts his attack in mid-strike. A look of terror comes over him and he slinks away into the trees. Whew!" says the leopard, "That was close! That old poodle nearly had me!"

Meanwhile, a monkey who had been watching the whole scene from a nearby tree, figures he can put this knowledge to good use and trade it for protection from the leopard. The old poodle sees the monkey heading after the leopard, and figures that something must be up. The monkey soon catches up with the leopard, spills the beans, and strikes a deal for himself with the leopard.

The young leopard is furious at being made a fool of and says, "Here, monkey, hop on my back and see what's going to happen to that conniving canine!"

Now, the old poodle sees the leopard coming with the monkey on his back and thinks, "What am I going to do now?" But instead of running, the dog sits down with his back to his attackers, pretending he hasn't seen them yet. Just when they get close enough to hear, the old poodle says, "Where's that darn monkey? I sent him off an hour ago to bring me another leopard!"

Moral of the story...

Don't mess with old farts. Age and treachery will always overcome youth and skill. 

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.