While recent eurozone consumer price data signalled a rise in inflation, this has generally been attributed to erratic calendar (seasonal) effects. What is perhaps less well understood is that the picture of underlying inflation is not quite as bad as one might think.
A-cyclical = a-typical?
April’s spike (headline inflation 1.7% after 1.4% in March, core inflation 1.3% after 0.8%) was almost entirely a services phenomenon: core goods inflation rose only modestly, from 0.1% to 0.2%. However, the core services measure jumped from 1.1% to 1.9%. Diving deeper and looking at the cyclical and a-cyclical components, the latest data – unsurprisingly – is assigning a significant role to the a-cyclical component (see exhibit 1).
This reflects Easter Sunday falling much later this year than it did last year, shifting the traditional Easter boost in the prices of package holidays, accommodation and airfares from mainly March (last year) to April (this year). It follows that, year-on-year, package holiday prices this spring were relatively weak in March and stronger in April.
What next for inflation?
It should be noted that a-cyclical services inflation has been going nowhere in recent years, albeit in an erratic fashion.
So, what should we expect now? Core eurozone inflation will likely fall back to below 1%. A 0.9% forecast seems perfectly reasonable to us, but market talk of 0.8% or even 0.7% sounds quite aggressive.
Looking at the bigger picture, we believe core inflation is still stuck at low levels, but it must be noted that there are parts of the basket of goods and services used to measure inflation that are sensitive to the cycle of an economic recovery. The problem: that subset (cyclical services) accounts for only 30% of the overall basket.
Last month, the ECB noted that idiosyncratic domestic factors dampening growth were fading, but global headwinds had continued to weigh on eurozone activity. It said an “ample” degree of monetary accommodation was still needed to ensure that inflation remained on a sustained path towards its goal of levels below, but close to, 2% over the medium term.
Commenting on market concerns about the ECB’s ability to hit its inflation target, as reflected in the five-year-on-five-year inflation swap rate (see exhibit 2), central bank president Draghi agreed in April that weaker inflation expectations corresponded to a deterioration of the economic outlook, but noted that there had been no signs of abating pressure in the labour market.
He underscored that the ECB had plenty of instruments to take action and pointed out that it would tolerate inflation deviating from its objective, so long as the path of inflation converged to the medium-term goal.
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.