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Euro area core inflation lacks momentum

Summary:
Macroview Headline inflation in the euro area doubled in September as the impact of weaker energy prices declined, but core inflation was stable. As expected, euro area flash HICP inflation rose to 0.4% year on year (y-o-y) in September, from 0.2% in August as the impact of weak energy prices continued to fade. But measures of core inflation were slightly weaker than expected, remaining stable at 0.8% y-o-y against expectations of a small rise.Weaker industrial goods inflation in particular is to blame for the lack of momentum in the broader core index. Services prices are picking up at a slightly faster pace but, overall, we expect core inflation to rise only slowly in the quarters ahead, to around 1.25% by end-2017. This alone provides the European Central Bank (ECB) with a strong argument to maintain a very accommodative monetary stance. We still forecast headline HICP inflation in the euro area to average 0.2% in 2016 and 1.3% in 2017. Risks to the medium-term outlook for price stability remain to the downside, in our view, forcing the ECB to err on the dovish side for now.While we expect the ECB to act in December, extending its quantitative easing (QE) scheme by at least six months and announcing technical changes to address the scarcity of government bonds it can buy as part of QE, we suspect that pressure will remain on the Governing Council to do more.

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Headline inflation in the euro area doubled in September as the impact of weaker energy prices declined, but core inflation was stable.

Euro area core inflation lacks momentum

Sept 30 euro area inflation

As expected, euro area flash HICP inflation rose to 0.4% year on year (y-o-y) in September, from 0.2% in August as the impact of weak energy prices continued to fade. But measures of core inflation were slightly weaker than expected, remaining stable at 0.8% y-o-y against expectations of a small rise.

Weaker industrial goods inflation in particular is to blame for the lack of momentum in the broader core index. Services prices are picking up at a slightly faster pace but, overall, we expect core inflation to rise only slowly in the quarters ahead, to around 1.25% by end-2017. This alone provides the European Central Bank (ECB) with a strong argument to maintain a very accommodative monetary stance. We still forecast headline HICP inflation in the euro area to average 0.2% in 2016 and 1.3% in 2017. Risks to the medium-term outlook for price stability remain to the downside, in our view, forcing the ECB to err on the dovish side for now.

While we expect the ECB to act in December, extending its quantitative easing (QE) scheme by at least six months and announcing technical changes to address the scarcity of government bonds it can buy as part of QE, we suspect that pressure will remain on the Governing Council to do more. At the bank’s meeting next March, the ECB’s staff forecasts will be extended out to 2019, with the risk that these forecasts reveal the possibility that price stability is not met within a 2-3 year horizon.

All in all, a key concern for the ECB will be that underlying price pressures lack momentum, even though headline inflation still chimes with staff forecasts.

Mr. Frederik Ducrozet is a Senior Econoist at Banque Pictet & Cie SA, Research Division. Prior to this, he served as Senior Eurozone Economist at Credit Agricole Corporate and Investment Bank, Research Division from June 2006 till September 2015. He joined Crédit Agricole SA in 2005. Mr. Ducrozet contributed to the various publications of the research department, with a special focus on macroeconomic developments in Eurozone countries, including on the outlook for fiscal policy and the ECB’s monetary policy. Nadia Gharbi is economist at Pictet Wealth Management. She graduates in Université de Genève, Les Acacias, Canton of Geneva, Switzerland Do not hesitate to contact Pictet for an investment proposal. Do not hesitate to contact Pictet for an investment proposal. Please contact Zurich Office, the Geneva Office or one of 26 other offices world-wide.

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