Euro area deflation monitor

Inflation outlook

Euro inflation declined to a new cycle low of 0.5% in March. This is the lowest rate of inflation in more than four years and far below the ECB’s 2% target. In the coming months, positive base effects are set to put slight upward pressure on inflation but we expect it to stay below 1% until mid-2015. We continue to forecast average inflation at 0.7% in 2014, increasing slightly to 1.0% in 2015 (see more details on page two).

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 above 0.5% in H2 13. This is a clear improvement from its previous decline in 2011-12.

Deflation index

In Danske Bank’s Euro Area Deflation Index below, all countries are placed at or below zero and the overall euro area has moved down to -6 from -5 in our index. Germany is now negative in our index and the scores of France and the Netherlands are around those of the periphery countries. Headline inflation is below 1.5% in all countries.

• The score of all the core countries is negative but is held up by activity indicators. 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 wage pressure. This is partly a result of an adaptation of competitiveness, which is necessary to restore sustainable economic growth. However, the risk is that the economies end up in a low inflation equilibrium.