Eurozone: Drop in inflation provides reality check - ING

Bert Colijn, Senior Economist at ING, notes that the Eurozone’s headline inflation and core inflation dropped back to 1.4% and 0.9% respectively in May despite the lowest unemployment rate more than eight years. Expect a cautious ECB next week.

Key Quotes

“While concerns about the ECB being behind the curve have been rising over recent weeks, May’s inflation rate should be a wakeup call. Self-sustaining inflation of “just under 2%” is still far away as core inflation has not managed to push above 1% in recent months except for April, which was due to a late Easter. In fact, businesses have recently been indicating that selling price expectations have been weakening again and wage growth is still very weak. The lower oil price and stronger euro are causing import prices to decline, while base effects in energy prices are also putting pressure on headline inflation in the months ahead. This means that further weakness in headline inflation in 2017 is more likely than a rebound to 2%.”

“Key to future price pressures are current labour market developments. The decline in the unemployment rate to 9.3% in April shows that the labour market maintains its relatively strong momentum. This is an encouraging sign for the return of wage pressures, even though significant underemployment is delaying the impact on wage growth for now. Still, labour shortages in certain markets are increasing. Some pickup in wage growth could be expected in the second half of the year, but this is unlikely to be enough for a significant impact on inflation.”

“This makes for a difficult situation for the ECB as robust growth and weak price pressures bring about diverging expectations of policy. The ECB will be cautious with its plans for monetary policy to avoid a ‘taper tantrum’, but a change in communication on the balance of risk and the forward guidance can be expected next week. Still, May’s weak inflation rate suggests that the ECB is unlikely to be in any rush to change anything more than communication.”