Core inflation stuck at its record low

In March, euro zone HICP picked up further from -0.3% Y/Y to -0.1% Y/Y, although remaining in negative territory. The rebound in the oil price was the main reason behind the further increase in headline inflation.

Core inflation back at record low level

Despite the pick-up in headline inflation, core inflation dropped again in March. Core inflation slowed from 0.7% Y/Y to 0.6% Y/Y, reaching again its record low. This indicates that downward price pressures are not only due to the lower oil price. Nevertheless, the slowdown was partly related to negative base effects and swings in seasonal adjustment factors around the timing of Easter. Also in April, the inflation data might remain volatile due to difficulties in seasonal adjustment around Easter.

Looking at the sector breakdown, the rebound in inflation last month was only based in the goods-producing sector. Quite disappointing was the slowdown in inflation in the services sector, despite strengthening domestic demand. Volatility around the Easter holidays might also be part of the explanation. A closer look at the sector breakdown shows that deflationary pressures are mainly based in energy-related sectors, following the sharp correction in the oil price. Overall however low inflationary pressures are broad-based across product groups. Slightly positive, the number of product groups with negative annual inflation rates dropped slightly further in March, from 34% to 32%. But still almost one in three product groups is observing negative annual inflation. Although there are no real signs of second-round effects stemming from the recent oil price drop, there are neither signs that underlying price pressures are starting to pick up, boosted by reviving domestic demand.

The breakdown by country indicates that deflationary pressures are still broad-based across countries. Only three of our selection of 11 countries are still observing positive annual inflation, but encouragingly inflation picked up in nine countries in March. In the meantime, 10-year inflation expectations, derived from the swap market, picked up further and are currently at 1.5%, up from 1.4% one month ago and a low of 1%. The ECB’s closely-watched 5yr 5yr forward however failed to rise further and continues to hover around 1.7%, suggesting that investors are still sceptical about the effectiveness of the ECB’s QE.

Inflation to pick up significantly in the second half of the year

While headline inflation picked up further in March, although remaining negative for now, core inflation remains stuck at its record low. For now, there are no signs that strengthening domestic demand is starting to push prices up in the euro area and also the weaker euro is not yet having a meaningful impact on inflation.

In April, inflation might remain volatile, due to the timing of Easter and the Easter holidays. Afterwards, we hope to see inflation picking up supported by strengthening domestic demand and the weaker euro. This should also start to push core inflation off its record low. In addition, in the second half of the year, the headline inflation rate will be lifted significantly by positive base effects stemming from last year’s drop in oil and other commodity prices.