Euro area deflation monitor

Inflation outlook

Euro inflation remains far below the ECB’s 2% target and was 0.7% in February. We expect it to reach a new cycle-low of 0.5% in March. In coming months, positive base effects are set to give a small upward pressure on inflation but we expect it to stay below 1% and we maintain our view that average inflation will be 0.7% in 2014 and only increase slightly to 1.0% in 2015.

The lower inflation is not contradicting stronger growth in the euro area, in our view. Lower commodity prices have increased purchasing power and although there was a decline in wage growth in Q4 13, real wage growth was 0.6% in H2 13. This is a clear improvement from its previous decline in 2011-12.

Deflation index

As it appears in Danske Bank’s Euro Area Deflation Index below, all countries are placed at or below zero. Considering HICP and its subcomponents, all countries have headline and core inflation below 2%. The only rates which are above 2% are food price inflation in Germany and Austria.

• The score of the core countries is held up by PMIs and GDP growth not too far below potential growth. Inflation should slowly increase as the recovery puts upward pressure on wages, but due to slack in the economy the pressure should be limited. Moreover, the upward movement will be countered by low commodity price inflation.

• The periphery countries are at the low end of the index and inflation is set to remain very low as high unemployment limits the wage pressure. This is partly due to an adaptation of competitiveness, which is necessary to restore sustainable economic growth. However, the risk is that the economies end in a low inflation equilibrium.