Market Economics | Interest Rate Strategy - BNP PARIBAS ...

upward trend evident since 2005 in the first part of
this year. But following the latest leg of the rally,
whether you assume the price moves higher from
here, moves flat at current levels, or declines back to
that trend, the levels reached in recent weeks imply
our forecast for a peak in food HICP inflation of
around 3.5% later this year now looks conservative.
Accordingly, we have raised our forecast, with a peak
rate of food inflation a pp higher in the second half of
this year.
…with indirect implications for core…
The latest rally in soft commodity and oil prices has
implications for ex-food, ex-energy inflation too.
First, it will have a lagged knock-on impact on a
number of core categories particularly affected by
commodity prices – so called ‘indirect effects”. For
example, the restaurant component of core HICP
typically reacts to a food price shock with a six month
lag (Chart 4). Similarly, there is indirect pass-through
from energy prices to transport prices as the cost of
travel rises. This occurs with a fairly long lag –
around 9 months traditionally – so has implications
for core inflation more in the latter part of 2011, into
2012.
…but second round effects likely to be limited
Second, a commodity price shock can have ‘second
round effects’ on inflation. If a spike in commodity
prices feeds through to inflation expectations,
resulting in higher wages for labour, then a jump in
commodity prices can have a far broader impact on
prices in the economy.
We are sceptical, however, that in the current
environment of high unemployment and tighter fiscal
policy, workers across the euro area as a whole have
sufficient bargaining power to convert higher inflation
expectations into significantly strong wage growth.
Labour market developments typically pass-through
to wages with a long lag in the euro area (Chart 5).
The peak fallout on the labour market from the
recession is still weighing heavily on labour costs.
The subsequent slowdown in the pace of
unemployment growth is pointing to stronger wage
inflation on the horizon, but to relatively tame levels.
The prospect of fiscal tightening across many
countries in the euro area should also limit the extent
to which the commodity price spike can be
transmitted to the broader economy via wages.
Germany’s economic renaissance
The other major development since our last inflation
update has been the vibrancy of the German
economic recovery.
While Germany suffered an output collapse as large
or larger than the other principal eurozone
Chart 4: HICP Food & Hotels/Restaurants
Source: Reuters EcoWin Pro
Chart 5: Eurozone Labour Costs & U/R
Source: Reuters EcoWin Pro
Chart 6: German Output Gap & Core HICP
Inflation
Source: Reuters EcoWin Pro
economies during the recession, it has
disproportionately benefited from the rebound in
world industrial activity. The strength of the industrial
sector has spilled over into the labour market. The
unemployment rate is now lower than at any time
since the early 1990s, even as the unemployment
rate across the eurozone as a whole reaches a new
12-year high. It has also spilled over into domestic
demand – first into investment and, we expect,
increasingly into consumption. To reflect our
Eoin O’Callaghan 20 January 2011
Market Mover
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