Euro area deflation monitor

Inflation outlook

Euro inflation declined back to 0.5% in May and stays far below the ECB’s target. In response, the ECB eased monetary policy with a package of measures, which will gradually put upward pressure on inflation (see Implications of the ECB easing measures, from 6 June 2014). 

The ECB’s stimuli will affect the real economy with a lag and we forecast inflation to stay around current levels or go slightly lower during Q3. Later this year, we expect an increase to around 0.9% partly as higher global food prices will increase food consumer prices. When the impact of the ECB’s policy kicks in and the recovery gains more ground, wage growth should add to higher inflation. We lower our inflation forecast to 0.6% from 0.7% in 2014 but we still expect inflation to increase to 1.1% in 2015. 

Lower inflation is not contradicting stronger growth in the euro area. Lower commodity prices have increased purchasing power and although there was another decline in nominal wage growth in Q1 14, real wage growth remained positive at 0.5%. This is a clear improvement from the previous declines in real wages in 2011-12. 

Deflation index

In Danske Bank’s Euro Area Deflation Index, all countries are placed at or below zero and a number of countries have a lower score versus the previous month. 

• The scores of the core countries are low but are overall held up by activity indicators. The German score is again negative after inflation declined to 0.6% in May despite very low unemployment. France and the Netherlands still have really low scores. 
• The periphery countries are at the low end of the index and inflation is set to remain 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.

Inflation outlook details

The ECB’s easing measures should put upward pressure on inflation through stronger economic activity and a weakening of the exchange rate. Based on OECD’s new global model we expect the negative impact on inflation from the weaker currency to be reduced to -0.10pp from -0.25pp in a situation of an unchanged exchange rate. This should reflect improved price competitiveness together with higher imported inflation. 

Core inflation declined back to 0.7% in May. We expect a gradual increase during 2014 to 1.0% in Q4. The modest increase should reflect weak price pressure from the labour market. In Q1, nominal wage growth declined to 1.2% although the unemployment rate has started to decline. The short-term unemployment rate has been a better indicator for wage pressure during the crisis and it points to an increase in wages. Slack in the labour market is likely to limit wage pressure when the recovery strengthens further. 

There will be a negative impact on core inflation when the impact from tax hikes drop out in 2015. Currently, taxes add around 0.2pp to core inflation. 

Inflation in food prices decreased to 0.1% in May, which is the lowest rate since February 2010. We expect a negative print in food consumer price inflation in June but looking further ahead the increase in global food prices at the beginning of 2014 should put upward pressure on food inflation. Usually, it reacts with a lag of three quarters; hence, we expect to see the impact in Q4 when positive base effects will also be supportive. 

Energy price inflation was 0.0% in May after being negative for the first four months of 2014. We expect it to decline below zero again in H2 due to negative base effects. The forecast also reflects a boost to oil supply by new technology to make the most of shale formations, while demand is slowing as growth in China is less energy intensive.