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The ECB Explains Inflation, In One Chart

Courtesy of ZeroHedge. View original post here.

One of the reasons for the recent historic flattening in yield curves is not just the ongoing disappointment in inflation prints which have missed expectations for the past three months, but also the ECB’s recent sharp downward revision to its inflation forecasts, which as it revealed in its latest policy meeting, were cut across the board, with HICP now expected to drop from 1.6% to 1.3% in 2018, sending Bund yields tumbling.

That the sharp drop took place even with the ECB’s balance sheet rising to record highs of €4.232 trillion as of the latest week…

… would suggest that Mario Draghi does not have a firm grasp on just what it is that driver inflation. However, the ECB would beg to differ, and in its latest bulletin, the central banks lays out what and how it believes inflation is created in one chart. Here’s what it says:

In the short term, fluctuations in inflation are affected by both domestic and external developments. The following part discusses the main drivers of inflation on the domestic as well as on the external side. Chart 1 gives a stylised overview of the drivers of inflation in terms of the harmonised index of consumer prices (HICP). The HICP, which is the benchmark indicator for the price stability target of the ECB, is based on a broad basket of goods and services. The main components of the consumption basket used to calculate the HICP are commonly grouped into energy, food, services and non-energy industrial goods (NEIG). HICP inflation excluding energy and food, which consists of services and NEIG inflation, is one measure of underlying inflation.

And visually:

Looks like the ECB has it all figured out, except perhaps for the elephant in the room (see chart in the middle) and, of course, money supply. And yet there continues to be a glaring disconnect between theory and practice. If only Draghi and company could take this lovely representation of their financial models and apply it to the real world, promoting healthy price inflation across the broader economy and not just asset prices, Europe would be truly “fixed.”


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