Overview: Consumer prices took another steep decline in December, dropping 0.7% m/m and forcing the annual growth rate to 0.1% from 1.1% in November. Core inflation came in flat on the month for a second month in a row, implying another decline in annual core inflation to 1.8% from 2.0%.

Details: There are two major factors behind the sharp decline in inflation. Firstly, with oil prices coming down from close to USD 150 per barrel to below USD 40 per barrel, the energy price index has declined dramatically. Overall energy prices dropped 8.3% in December following a 17% decline in November and gasoline prices were down 17.2% on the month.

Secondly, heavy discounts in December as retailers are flushing out inventories are now showing up in the core inflation data. Core goods prices declined 0.3% m/m and core service price inflation ex. housing has shown a rapid decline over the past three months.

Assessment & Outlook: Headline inflation is approaching zero and we expect inflation to move into negative territory in January for the first time since 1955. Going forward, both core and headline inflation are poised to slow further. We now look for headline inflation to trough at -2.5% y/y – a multi decade low – by mid next year. Ongoing inventory liquidation, easing wage pressures and fading impetus from commodity prices will secure that core CPI inflation will be slowing relatively fast as well. We expect the core to dip below 1.2% during H2 2009.