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For Inflation, It's All About Oil

The Wall Street Journal. logo The Wall Street Journal. 4/14/2017 Richard Barley
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Inflation has sprung back to life around the world recently, bringing with it expectations of higher growth and tighter monetary policy.

But much of that revival has been caused by the rebound in oil prices from their tumble at the start of last year, and those effects are already fading. The coming months will be a better guide to true inflationary pressures—with potential consequences for markets and monetary policy.

U.S. inflation and retail-sales data out Friday show the shift. Headline inflation fell back in March to 2.4% from 2.7% in February due largely to falling gasoline prices. Core prices, which exclude food and energy, were up 2%—their lowest annual reading since November 2015.

Separately, a second straight month of falling U.S. retail sales signals that growth hasn’t accelerated along with the higher inflation figures. Economists have ratcheted down their growth forecasts, with The Wall Street Journal’s Economists Survey showing a decline in first quarter gross domestic product from 2.3% in December to 1.4% this month.

Oil’s swings have been big in both directions. The persistent decline that started in mid-2014 only hit bottom in early 2016; the recovery to around $50 a barrel from 2016’s lows was swift. As a result, on the downward trip oil acted as a protracted drag on headline inflation, but on the rebound it has caused a spike. In January, a barrel of Brent crude was around double the price it was a year earlier; now it is 27% higher than a year ago. If oil prices stick around current levels, then in the next couple of months, much of this effect will wash out.

That swing has played out in the inflation numbers. In the U.S., annual energy inflation has moved to 10.9% now from minus 12.6% in March 2016; in the eurozone, it was minus 8.7% in March 2016 and is now 7.3%. Headline inflation has duly risen too. Rising inflation has changed the debate about monetary policy in markets. With the U.S. Federal Reserve already gently moving to tighten policy, the spotlight has fallen on the European Central Bank’s exit from unconventional measures, particularly since the ECB’s mandate focuses on headline inflation.

But the oil peak is old news now. Headline inflation rates in March also fell back versus February in the eurozone, to 1.5%, as the energy push retreated. True, in the U.S., the inflation outlook is much more solid, although there is still a puzzle about the lack of wage pressures given the relative tightness of the labor market. That bears watching closely.

In the eurozone, by contrast, the underlying rate of inflation remains weak: Services inflation, a proxy for domestically generated price pressures, was 1% in March and has essentially flatlined a little above that level for more than three years. Market-based measures of medium-term inflation expectations have held up in the U.S.; they have slipped in the eurozone again.

The rise in inflation has coincided with a buzz about the prospect of reflation and escape from the ultra-loose monetary policy that has dominated markets in recent years. That buzz is partly relief that deflation didn’t take hold, but was just an oil-fueled panic. Headline data in coming months, once the oil rush wears off, will be a better guide to the real picture for inflation.

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