Disinflation: prices are still rising, but the rate is already turning

Disinflation is a slowdown in the growth of prices, not a fall in them. Inflation stays positive, goods and services keep getting more expensive, but with each successive month the increase in the price level is smaller than the previous one. This is a fundamentally different state from deflation, in which the price level declines. For an investor, disinflation matters not in its own right: it is the condition under which the central bank gains room to ease monetary policy, which means that the whole yield curve, and everything that depends on it, is repriced.

Three different phenomena that get confused

Inflation is the rate at which prices grow. Disinflation is a decline in that rate. Deflation is a negative rate, that is, a fall in the price level. There is also a fourth state, rarely mentioned in public discussion: a slowing rate while the level remains high, when prices have already moved far up and have simply stopped accelerating. The consumer feels no relief at that moment, because they compare the till receipt not with last month but with their memory of past years. Hence the classic gap: the statistics record disinflation, while inflation as observed by households stays higher. The gap does not mean that the statistics lie: they measure the derivative, while a person feels the level.

Why monthly data speak earlier than annual data

Annual inflation is a comparison of the current price level with the level of a year earlier. Such a measure inherits everything that happened over the intervening months, and therefore lags. If a price jump happened long ago, it will sit in the annual figure until it drops out of the comparison base. This base effect can create the appearance of disinflation without any easing of current price pressure at all, and, conversely, can hide a real slowdown.

That is why the turning point is sought in seasonally adjusted monthly increases, converted to an annualised rate. In addition, analysts look at measures of underlying price growth: the index excluding the most volatile components, trimmed means, median price growth, and services inflation separately from goods inflation. Services are a domestic, labour-intensive segment whose prices are tied to wage dynamics, so disinflation that has not reached services usually proves fragile.

The mechanism: what exactly slows prices down

Sustained disinflation does not come from persuasion. Several channels work at the same time.

The interest rate channel: a high key rate makes credit more expensive and saving more attractive, part of demand is shifted from the present into the future, and demand stops outrunning supply. Transmission works with a lag of several quarters, and this is the key reason why the regulator does not react to one good month.

The exchange rate channel: a stronger national currency makes imports and the commodity components of production costs cheaper. The channel is fast but reversible: it delivers a one-off disinflation, not a trend.

The supply channel: a good harvest, the clearing of logistics bottlenecks, the recovery of deliveries. This too is a one-off factor: the effect passes through the index once and then drops out of the base.

The expectations and budget channel: if businesses and households stop building rapid price growth into contracts, and government demand does not add a new impulse, disinflation becomes entrenched. An expansion of budget spending, on the contrary, can cancel out the effect of a tight rate.

What is repriced in the market

The debt market reacts first and most strongly. An expectation of sustained disinflation means an expectation of a lower key rate, and therefore falling yields and rising prices of fixed-coupon securities already in issue. Long issues are more sensitive than short ones: the longer the term to maturity, the higher the duration and the larger the price change for the same change in yield. The state of the OFZ curve is convenient to follow in the government bonds section, and the corporate segment with its spreads in the general bonds section.

For equities the picture is more complex and cuts both ways. A lower rate reduces the discount rate applied to future cash flows, which supports valuations, especially for growth companies and for heavily indebted issuers, whose debt service becomes cheaper. But disinflation is almost always accompanied by cooling demand, and therefore by pressure on revenue and margins, and for companies that used to pass costs through into prices this opportunity narrows. The reaction therefore splits by sector, and what needs to be examined is the reporting of specific issuers: publications of financial results are collected here.

Dividends are a separate story. When debt yields fall, the dividend yield of equities looks relatively more attractive, and part of the capital is reallocated in favour of stocks with stable payouts. The calendar of upcoming payouts helps to compare dates, and the general dividends section shows history and regularity.

How not to mistake a pause for a trend

Disinflation is false until proven otherwise: any slowdown should be broken down into what is one-off and what is sustained. The test questions are simple. Have services prices slowed, and not only fruit and vegetables and imports? Is lending growth declining, along with the pace of wage growth? Is a base effect at work? Is the regulator itself talking about easing conditions, or still about keeping policy tight? Rate decisions and the release dates of statistics are convenient to track in the events calendar, and commentary and releases in the news feed.

A short glossary on the topic

The terminology that comes up in discussions of monetary policy, such as duration, real yield, the yield curve and the base effect, can be checked in the site glossary. If you need an instrument that does not involve picking individual securities directly, the fund-based approach is described in the funds section; a selection of equities is in the Russian equities section.