Deflationary pressures starting to ease

Euro zone inflation marginally positive

Euro zone HICP picked up further in April, entering again positive territory after four consecutive months of negative inflation. The increase in inflation is mainly a result of the rebound in the oil price since January.

Core still stuck at its record low

Although headline inflation has now picked up significantly from its bottom reached in January (-0.6% Y/Y), core inflation remains stuck at its record low of 0.6% Y/Y. This indicates that the recent rebound in headline inflation is mainly due the pick-up in the oil price, while underlying inflationary pressures remain limited.

Looking at the sector breakdown, the rise in inflation in April was again only based in the goods-producing sector. Quite disappointing was the slowdown in inflation in the services sector (to 0.95% Y/Y from 1.02% Y/Y), despite strengthening domestic demand. Volatility in March and April was however somewhat higher than usual, due to seasonal factors related to the timing of the Easter holidays. A closer look at the sector breakdown shows that deflationary pressures remain 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, although downward price pressures are starting to ease. The number of product groups with negative annual inflation rates dropped significantly further in April, from 31% to 26%, falling for a third straight month. While in March, almost one in three product groups was observing negative annual inflation, it was only one in four in April. Although core inflation remains stuck at its record low level, a closer look at the details provides cautious signs that underlying price pressures are starting to pick up.

Also the breakdown by country suggests that deflationary pressures are easing with less countries observing negative inflation. Five countries of our selection of 11 are again observing positive annual inflation, while it were only three in March. In the meantime, 10-year inflation expectations, derived from the swap market, picked up further and are currently above 1.5%, up from their lows of 1%. The ECB’s closely-watched 5yr 5yr forward however picked up further too and is again above 1.8%, edging closer to the ECB’s 2%-target, which suggests that the ECB’s measures are starting to bear fruit.

Core inflation to pick up soon?

Euro zone headline inflation is again marginally positive (0.01% Y/Y), but core inflation fails to pick up for now. Although domestic demand is picking up, it fails to boost prices in the services sector (for now). As the distortions around the Easter holidays should have faded in May, we hope to see signs of a pick-up in price pressures in the services sector.

Inflation should also be supported by the weaker euro and a further cautious rebound in commodity prices. As a result, we hope to see core inflation finally picking up from its record low level in the coming months. 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.