ECB’s core inflation forecast is still too optimistic

Danske Research Team Danske Bank A/S

The ECB revised its headline inflation projection considerably higher in 2017, lifting it slightly in 2018 while keeping it unchanged in 2019. The higher near-term inflation forecast reflects higher energy and food price inflation forecasts from the ECB whereas the core inflation projection was unchanged at 1.1% in 2017.

The ECB revised its core inflation forecast slightly higher for 2018 and 2019 by 0.1pp in both years due to ‘some indirect and second-round effects from higher oil prices, as well as some upward effects from the lower euro exchange rate’, see March 2017 ECB staff macroeconomic projections for the euro area.

In our view, the ECB’s core inflation forecast is still very optimistic due to the following:

1. The ECB’s core inflation forecast hinges on higher wage growth

2. Labour market slack suggests wages will stay low in 2017-18

3. Even German wage growth is low despite the tight labour market

4. The ECB’s model for core inflation is subject to mean reversion

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Author

Danske Research Team

Danske Bank A/S

Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.

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