THE SHORT VIEW By John Authers Monday's surprise to the upside on growth in the eurozone, UK inflation yesterday came in much better - Finantial Times

THE SHORT VIEW By John Authers
Copyright The Financial Times Limited 2006
Published: August 16 2006 03:00 | Last updated: August 16 2006 03:00


The world's financial economists are not having a good week. Following Monday's surprise to the upside on growth in the eurozone, UK inflation yesterday came in much better than expected, and US producer price numbers caught the market off-guard.

It is usual for some forecasters to be off the mark. But all the economists contacted for the Bloomberg survey ahead of the results expected the core producer price index (excluding energy costs and food) to increase (by about 0.1 per cent). Nobody expected a decrease. But that is what happened, by 0.3 per cent. It is extremely unusual for all of Wall Street to be wrong not only about the magnitude of the change in an important economic number but also about its direction.

While the number was surprising, its impact on the bond markets was predictable. US Treasury yields dropped by 7 basis points across the curve. Fed Funds futures now put the odds of a rate rise next month at less then 25 per cent.

However, the extent to which the PPI - a volatile indicator - took the market by surprise raises the question of whether there is something suspect about the number itself. And the number is indeed not as positive as it first appears.

Car prices fell 0.8 per cent last month, while light trucks, the category worst hit by resurgent fuel-consciousness, fell 3.1 per cent. This reflects desperate discounting and incentives packages on offer but is still surprisingly high.

According to Morgan Stanley's analysis, excluding autos as well as energy would leave the PPI showing a 0.1 per cent rise - exactly in line with expectations. Thus the Street was not wildly out in its grasp of inflationary pressures. It merely failed to take into account the desperation of people trying to sell cars. Morgan Stanley went so far as to brand the PPI's motor price numbers a "random outcome".

There is more bad news hidden in the details of the PPI report. Unnoticed in the excitement, electricity and natural gas prices rose more than expected. These are not in the "core" PPI but they could yet have real economic impacts. Sadly, yesterday's bond market reaction looks premature.