Inflation: Past and Present
Inflation keeps momentum, and reaches a new height. That is expected; if it does continue in May also, then we will have to revise our outlook, albeit in a very conservative vein. We keep our target range at 8.50-9.50% by the year end. Anyway, our key take to the effect that CPI will either fall early, by mid-summer, or only in December remains valid. The estimate can be overshot by a few basis points, i.e. 9.75% instead of 9.50%, but we don’t ’impute much weight to this likelihood.
We reiterate that this outlook is contingent upon the absence of a new permanent exchange rate shock. Producer prices show that the shock of H2 2016 still have a bearing on wholesale inflation, and this is what keeps it going north in terms of both monthly and 12-months MA data, as the table below displays. Intermediate goods & consumer durables carry the PPI upwards most. There is still a huge difference between the first months of 2016 and 2017. There is also a sizeable increase in terms of 12-months MAs. Hence, the pass-through did not die away this month either. In either view, CPI will remain or will have remained in low double-digits for at least 6 months, possibly for 11 months. That alone calls for a tight monetary policy, which is also a must from the standpoint of currency stabilization. In turn, currency shocks easily and rapidly translate into inflation, and risks of producing inertia in prices. Long-memory dependence was a vice of the past, and as inflation was ‘conquered’ in the early 2000s, this kind of pricing behaviour was forgotten. According to standard pass-through calculations through vector auto-regressions, the pass-through effect should fall down visibly this month. For the CPI, clothing and footwear is seasonal. Food is still high. The whole curve seems to have moved up, and that explains why most commentators think CPI can only fall to single-digits in December as a result of a large favourable base effect. That is a distinct possibility, but we still attach a good possibility for an early turn, down to below 10% in July. However, although worried about the scope and pervasiveness of PPI behaviour, we still have good reasons to think a kind of mean-reversion is in the cards, although the inflationary mean we may return to will be higher than the 6.5-7% of post-Lehman years. We may have to plug in an 8-8.5% trend CPI for the years to come, at least 1.5% higher than what past data suggest.