Moving closer to deflation

The US economy moved a bit closer to deflation in September, when core consumer prices were unchanged for the second month in a row and the annual growth rate fell to a 49-year low of just 0.8%. (See Chart.) It is this gradual downward trend that will probably prompt the FOMC to announce a secondround of quantitative easing (QE2) when it meets in November. Expectations of such action have already boosted equity prices and the gold price and pushed Treasury yields and the dollar lower. Nonetheless, we are not convinced that QE2 will prevent inflation from eventually falling to zero.