Many market observers have noted that the recent drop in consumer price index (CPI) inflation seems to be related to the dramatic fall of crude oil prices between July 2014 and January 2015.2 In this post, we predict the future behavior of annual CPI inflation under three scenarios for the future behavior of oil prices.
In all three scenarios, oil prices remain fixed until the end of 2015 at $52 per barrel.3 The three scenarios then differ in the behavior of oil prices during the first half of 2016:
In the first scenario, oil prices remain flat at $52.
In the second scenario, oil prices rebound to $100.
In the third scenario, oil prices drop further to $20.
The scenarios then say that prices are fixed after June 2016...
To simulate future inflation, we assumed that the other components of the CPI (such as food, shelter and medical care) keep inflating at the rate observed between January 2015 and August 2015.
Here's their result:
I don't believe there is much of a chance of oil prices hitting new lows. I also expect that the components that Badel and McGillicuddy held at a steady growth rate will actually climb at an accelerated rate, So my expectation is for price inflation to surprise on the upside in 2016 at plus 3%.