EUROZONE RISK TO U.S. : LOW INFLATION MORE THAN WEAK GROWTH / THE WALL STREET JOURNAL

October 21, 2014, 11:39 AM ET

Eurozone Risk to U.S.: Low Inflation More Than Weak Growth

By Pedro Nicolaci da Costa

 

Federal Reserve officials have said the latest round of soft eurozone economic data is not enough to worry them about the U.S. outlook – or revise their fairly optimistic forecasts in the months ahead.

“It’s not really a surprise that growth in Europe has been underperforming for some time,” Boston Fed President Eric Rosengren said in an interview last weekend. “It may be a little bit softer, not dramatically softer. The inflation numbers have been coming in maybe a tenth or two [of a percentage point] lower than they were expecting.”

That may be the case. But for Paul Mortier-Lee, economist at BNP Paribas, slipping inflation may be a more dangerous channel of contagion than weak growth – something that would still pose a problem for Fed officials, who have undershot their 2% inflation target for more than two years.

“The impact on inflation looks to be much more serious and should worry the Fed, in our view, as inflation expectations globally seem to have been fraying at the edges,” Mr. Mortimer-Lee writes in a research note to clients. “Thus, the U.S. will probably not catch Europe’s stagnation, but it could get a bad case of unwelcome disinflation.”

The reason, he says, is that import prices may be having a greater effect on underlying or core U.S. inflation than they have in the past.

“The evidence does suggest a stronger relationship between import prices on the core Consumer Price Index in the last two to three years,” Mr. Mortimer-Lee says.

That would worry a number of Fed officials, whose preferred measure of consumer prices, the personal consumption expenditures index or PCE, has begun drifting lower again after a brief uptick.

Or maybe not. Research from the Cleveland Fed in September found a much weaker relationship between import prices and the costs of consumer goods.

The Fed has undertaken an aggressive response to a deep recession and soft economic recovery, keeping official interest rates near zero since December 2008 and buying over $3 trillion in government and mortgage bonds to support investment and hiring.