Research euro area: Measuring the euro area inflation pulse

Summary: measuring the euro area inflation pulse

1. Euro inflation rewind: negative inflation returns to the euro area.

• However, underlying inflation pressures are not as weak as core inflation would suggest.

2. Theme: inflation drivers in a post-corona world.

• Both anti- and pro-inflationary drivers can be found in a post-coronavirus world. While we see the balance of risk for higher inflation in the medium term, the long-term implications are less clear cut.

3. Euro inflation outlook: the battle between demand and supply side factors.

• The inflation prospects should brighten going into 2021, driven partly by technical factors but also by economic ones.

4. Inflation expectations and market dynamics: reflation doubts linger.

• Little evidence yet of higher selling prices explains why markets remain sceptical about reflation.

Negative inflation returns to the euro area

State of play: In August, headline inflation fell back into negative territory for the first time since 2016. A significant drag from energy prices on the back of the oil price fall in 2020 was an important factor behind this development but policy initiatives such as Germany's temporary VAT cut for H2 20 and an easing of service price inflation contributed to the fall.

The outlier: An outlier of the adverse price trends has been food price inflation. As the lockdowns in southern Europe were upended production and transport routes, prices for fruit and vegetables surged, with food price inflation reaching 3.4% in Q2 20 (up from 2.2% in Q1 20). That said, as lockdowns eased and supply chain disruptions abated, prices came down again in H2 20.

Policy implications: Although the current low inflation pressure is unlikely to cheer ECB policymakers, they have stressed their transitory nature. Still, with the economic outlook deteriorating due to second waves and renewed partial lockdowns, we look for a comprehensive ECB easing package to be unveiled in December (see ECB Review, 29 October).

Download The Full Research Euro Area