Eurozone’s Fall into Headline Deflation Confirmed

• Euro area headline HICP inflation (including food and energy) dipped below zero to -0.1% y/y in June 2009, the lowest since the start of the series, confirmed by Eurostat. Headline eurozone inflation will likely move out of negative territory later in 2009 due to weaker base effects. Medium-term inflation expectations remain in the European Central Bank’s 2.0% comfort zone. Core inflation (excluding food and energy) will remain low in the eurozone in 2009 but may not turn negative until 2010.

U.S. Inflation Trends: Deflation, Disinflation, Reflation or High Inflation?

• Core CPI (excluding food and energy) inflation slowed to 1.7% y/y in June 2009 due to flat price growth for housing and weaker prices for airfare. Headline CPI decreased by 1.4% y/y in June – the largest annual contraction since 1950 – led by a decline in energy prices. Headline PPI for finished goods fell -4.6% y/y during June 2009, albeit slower than May’s 5% drop. Core PPI inflation for finished goods lifted 3.3% y/y, accelerating from the May rate of 3.0%.

• In June, energy lifted the price strength with a 6.6% m/m bounce while food followed with a 1.1% m/m increase. Further deflation is in the pipeline as prices for goods at earlier stages of processing continue to fall steeply – headline intermediate goods prices declined -12.5% y/y in June, and headline crude goods dropped -40% y/y.

Chinese Reserve Growth Surges: Hot Money Inflows Resume?

• After two quarters with limited reserve growth, Chinese reserve accumulation re-accelerated in Q2 2009, indicating a resumption of capital inflows. The Chinese central bank manages the exchange rate to maintain stability against the U.S. dollar. The expectation that China will recover before the rest of the global economy or perform better seems to have contributed to a revival of capital into China despite investment restrictions. With the renminbi having returned to a quasi-peg, more inflows are likely.

• Chinese foreign exchange reserves rose to US$ 2.132 trillion at the end of Q2 2009 from US$1.9537 trillion at the end of Q1 2009. The headline reserve increase, the highest on record, implies that China is again receiving hot money inflows. Despite worries about the value of its U.S. assets, which make up about two-thirds of reserves, China has likely added dollar assets.