U.S. CPI; the Source of Inflation/Deflation Matters

U.S. CPI fell as much as 1.0 percent in October when a 0.1 percent decline in the Core CPI, which excludes food and energy as volatile items, was even more impressive.

But what does it mean for the economy? The answer depends on the sources of inflation/deflation. Price pressures can ease by different reasons. Demand and cost are two main sources of changes in inflation headlines.

A significant decline in cost-structure, like the recent sharp drop in commodities prices, could result in an increase in output but at lower prices. But when prices are falling in response to lower demand, may be because consumers are pessimistic about the future and cutting back in spending, then falling output and rising unemployment could be more probable.

It is the first time since 1982 that the Core CPI declines, reflecting that the slowdown has not been limited to commodities prices but it is now the whole economy which faces the danger of deflation.

It means nothing but lower interest rates. Following charts show the market's reactions after the CPI report. U.S. dollar weakened against its major counterparts though some analysts believe that technical reasons could be also blamed for that excessive reaction.