Inflation came in slightly higher in October, rising by 0.1 pp to 0.4%. Going forwards, we expect inflation to remain subdued. The recent fall in oil prices and weak domestic demand should continue to exert downward pressures on inflation.
Inflation came in at 0.4% in October, slightly higher than in September. The increase was due to the most volatile components of the HICP inflation, that is energy and food inflation. Energy prices indeed contracted at slower pace on yearly basis, as base effects limited the fall of the index that occurred over the month (on a monthly basis energy prices fell by 0.7% m/m after rising by 0.2% m/m in September), while food price inflation accelerated (from 0.3% y/y to 0.5% y/y). By contrast, the most domestically oriented core inflation lost another 0.1pp in October, easing to 0.7%.
Inflation should remain subdued going forwards. The recent fall in oil prices should continue to exert downward pressures on inflation. The energy component (around 11% of the headline index) is extremely sensitive to changes in oil prices. Yet, the fall of oil prices is likely to affect inflation throughout other channels Lower oil prices will push transportation and production costs even lower, leading to lower food and consumer good prices, which eventually, would lead to lower headline inflation readings. Last, but not least, lower oil prices might affect inflation expectations. It is worth remembering that a key ingredient of inflation expectations is actual inflation, which also, in a cycle, is a function of inflation expectations. Declining inflation rates might lower inflation expectations, and in a circular mechanism, actual inflation as well. Inflation expectations are also sensitive to oil prices developments. Several measures of inflation expectations derived from survey data or from financial markets have declined at faster pace recently, reflecting the fall in oil prices.
Admittedly, the fall in oil prices might also provide a boost for the fragile eurozone economic recovery. Thanks to a lower energy and food bill, households might decide to increase their spending on other items, with positive effects on different sectors of the economy. Yet, this effect might prove to be smaller than usual. Given the ongoing deleveraging process, households are likely to restore their savings, highly eroded during the crisis, before increasing significantly their expenditures.
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