Inflation turns higher, components encouraging

Headline inflation again above 0% Y/Y

Headline inflation eased since May and dropped back below zero in September, notably to ‐0.1% Y/Y from +0.1% Y/Y in August. The fall in energy prices is an important factor in the decline of overall inflation. In October inflation turned higher again. Headline inflation jumped by 0.2%‐points to 0.1% Y/Y, while core inflation held up better already for longer. It reached an all time low in April at 0.6% Y/Y and trended very gradually higher to 0.9% Y/Y in September and now even to 1.1% Y/Y.

Services and goods inflation higher

Looking at the breakdown, the details show a positive picture with prices of goods rising to ‐0.85% Y/Y in October from ‐1.02% Y/Y in September. Overall, deflationary pressures remain based in energy‐related sectors, like transport and housing, water, electricity & gas. Clothing and footwear prices went up to 0.45% Y/Y from flat, but prices in this sector are too volatile to draw already firmer conclusions. Furnishing prices showed little variation as did alcohol & beverage. Food price inflation on the contrary is clearly rising, up to 1.45% Y/Y in October from 1.16% Y/Y in September.

Services inflation stabilized at 1.2% Y/Y in the period from June to September, but rose to 1.35% Y/Y October. It reached a record low around 1% Y/Y in the period January‐ March 2014. The uptick in October services prices is encouraging, probably a consequence of the recovery of domestic demand over the last few quarters. A warning: the increase in services was located especially in education and recreation & culture sectors, where administrative pricing often plays a large role. Interestingly, for the first month in many years communication prices stabilized on Y/Y basis. It seems that the deflationary trend in communication is finally over, which is from the point of view of the ECB, who wants higher inflation, a positive feature.

Looking at the number of product groups, those with negative annual inflation rates fell rather sharply to 19% from 26% in September and 34% at the start of the year. So, there is no sign of deflation, i.e. being a generalized decline in goods and services prices.

The breakdown by country shows an improvement too with 9 of the 11 countries in our sample reporting higher Y/Y inflation and only Portugal reporting declining inflation.
Of the 11 countries only three had negative inflation rates (Spain, Greece and Finland) versus 6 in September.

Market‐based measures of inflation expectations rose a bit. The ECB’s closely‐watched 5yr/5yr forward rate stabilized around 1.75%, well below the ECB’s 2%‐target, but 10 bps higher versus previous month. Survey‐based inflation expectations (business and consumers) are still downwardly oriented.

No time for complaisance

The October inflation scoreboard clearly improved in most aspects. The Euro zone is clearly not in deflation, which is a generalized fall in prices. Upcoming ECB measures will help inflation move higher. The weaker euro is another positive for inflation and the basis effect coming from earlier declining energy prices will gradually lose its impact on inflation.

However, there is no room for complaisance. Global growth is still fragile and deflationary pressures are exported from China and commodities towards advanced economies (see PPI and import prices). No extra slack is absorbed, meaning that supply exceeds demand.
Even if risks for genuine deflation may be very low, inflation will remain well below the ECB 2% target. In a context of too high debt levels, low inflation hampers the gradual decline of debt and especially the debt to GDP metric. It constraints demand for goods and services from overburdened households, governments and/or firms.
Therefore, the ECB won’t be satisfied by the inflation status quo and will be looking for measures to stimulate inflation. The expected modest rise in inflation in 2016 as a consequence of basis effects won’t withhold the ECB from taking further action.

On the contrary it may convince them to bring extra stimulus forward to December. If the inflation picture improves in a couple of months, it strengthens the hand of those inside the ECB that don’t belief that these extraordinary measures are needed in a context of low but positive inflation rates with little to no deflation risk.

•  Download Full KBC Flash