Global Daily – European reflation?

by: Nick Kounis

In this publication: Eurozone economic confidence at boom levels. Eurozone inflation likely jumped in August. On the path of reflation, but rise in underlying inflation will take a while.

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Eurozone economic confidence at boom levels

Data out earlier today showed economic confidence and inflation moving significantly higher, adding to a range of indicators suggesting that the eurozone economy is improving. The European Commission’s economic sentiment indicator rose to 111.9 in August from 111.3 in July (consensus: 111.3). This indicator is now within a range consistent with past cyclical highs and GDP growth in the 3.5-4% area on an annualised basis. While we continue to think that the economy will grow at well-above trend rates (trend growth is at around 1.25%), we are sceptical whether growth will turn out quite so strong. One reason is that the economic sentiment indicator has more often than not tended to lag developments in GDP growth and therefore is not a reliable early indicator in shifts in momentum. In addition, while the drivers of the eurozone economy are favourable, they do not seem to be so positive that the economy will grow at three times (!) its trend rate on a sustainable basis. For instance, the strength of euro may have some negative effect.

Eurozone inflation likely jumped in August

Meanwhile, German and Spanish data each showed an acceleration of 0.3 percentage points in the annual rate of inflation. Spain’s HICP inflation accelerated to 2% in August from 1.7% in July. Germany’s rose to 1.8% from 1.5%. This suggests that the eurozone numbers (to be published tomorrow) will rise above the current consensus of 1.4% (from 1.3% in July). An upward effect from energy was to be expected, but we need to wait for the details of the eurozone data to get a sense about whether underlying inflationary pressures are rising (the consensus expects core inflation to be stable at 1.2%).

On the path of reflation, but rise in underlying inflation will take a while

So is the eurozone economy on the path of reflation? We think it is, though we think it will take time for underlying inflationary pressures to build. Certainly with the economy growing above trend, slack is being eaten up (with unemployment dropping) and this should eventually generate some inflation. However, unemployment is still high, so it will probably take a while for it to fall to levels where the labour market is tight enough to generate wage inflation. Indeed, labour market reforms may have led to a drop in the level of the unemployment rate where this may happen. In addition, the strength of the euro will curb import price inflation. In the near term we expect core inflation to be flattish and we do not expect a clear upward trend to be visible until during the course of next year. (Nick Kounis)