Is the Phillips curve finally coming alive in 2019?

Danske Research Team Danske Bank A/S

Euro area inflation outlook - key takeaways

We think the euro area Phillips curve is coming alive in 2019
Different measures of underlying inflation pressures have continued their gradual upward trend in 2018, but the impact of higher wages on core inflation has yet to materialise. A key ingredient for the wage pass-through to core inflation will be profit margin compression. In response to strong wage growth in Q2 and Q3 18, there are early signs that firms' profit margins have started to get squeezed from higher input costs.
Although it is difficult to say when exactly the 'tipping point' in terms of margin compression is reached, we expect the euro area (core) inflation Phillips curve to steepen in 2019, with core inflation likely accelerating from Q2 19 onwards.
We expect the eurozone core inflation uptrend to be mostly driven by higher services prices (due to higher input costs from wages), while the uptrend in goods price inflation will likely be more muted with the euro appreciation staying a downside risk factor.
The EUR inflation forward curve has continued to steepen in past weeks, as expectations of weaker economic growth raised doubts about the wage pass-through to core inflation. We think market pricing has turned too pessimistic on the core inflation outlook in the euro area.

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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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