Consumer Price Index (CPI) in the United States on Wednesday showed the indicator to dip to levels not seen since 2008 and this makes it a six years low for inflation. The reason for this print seems to be due to falling oil prices which are deflationary and I dare to say that more important is what is going to happen now.
Oil prices have dropped for more than a month now and market participants we’re hoping that the previous OPEC meeting in Vienna to bring a cut in production levels. Such a cut would mean of course lower quantities available and hence price should move higher and the sell-off would stabilize.
Not only did the OPEC meeting did not deliver on those expectations, but recent news shows that there is no other meeting planned until the middle of 2015. In plain English, no production cuts so the oil price will have to stabilize itself.
The reason for no cut stays mostly with the desire of Middle-East reach oil countries to fight back the US shale gas revolution and boom by forcing lower oil prices on weak US producers.
Will this strategy succeed? It remains to be seen. What we do know is that the effect of lower oil prices, while clearly representing a stimulus for developed economies, it is deflationary (or it fails to create inflation) and this is when central banks are stepping in.
The mandate of a central bank is price stability through keeping inflation below or close to two percent, but lower levels than zero pose a far greater threat for any economy as by the time consumption disappears, growth disappears as well.
Coming back to the United States inflation, the pressure the Federal Reserve faces now is to find the right solution to combine lower oil prices with a (still) robust economic growth (over 3%). This gives the US economy some leverage in fighting lower inflation. If it fails, however, to use this as a competitive advantage, then this “oil war” risks to impact major economies in the world negatively.
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