Core inflation looks set to remain subdued for a while yet – Eurozone inflation data out today (final estimate) painted a picture of relatively lacklustre price pressures. The headline rose to 1.3% yoy in March from 1.1% in February. This was mainly driven by a jump in food price inflation. We doubt that the trend is sustainable, as global food price indicators have been falling significantly over recent months and that is likely to dampen retail food price inflation going forward. Indeed, that will partly offset the impact on headline inflation of the likely rise in energy price inflation in the coming months. Overall, we expect headline inflation to accelerate a further (to a peak of 1.7% yoy over the summer) before drifting down again.
The ECB is closely watching trends in core inflation right now, which will be a key consideration in how quickly it makes monetary policy less accommodative. Core inflation has been remarkably stable over the last few months. Indeed, over the last six months it has been at either 0.9% yoy or 1% yoy. In March, core inflation was steady at 1% yoy. There were actually some special factors putting upward pressure on the core (higher indirect taxes and transportation services), which suggest that underlying inflationary pressures might be even softer than suggested by the published core inflation number.
The key question remains when and how quickly will core inflation pick up? Our view is that core inflation will only start to noticeably turn later in the year (around the autumn) and that the upward trend thereafter will be very slow. There are a number of considerations behind this view. First, the strength of the euro will weigh on import price inflation and subsequently core goods price inflation. In the year to February, import prices ex-energy fell by 0.6%. The relationship with the euro suggests that they have further to fall in the coming months, and the drop could reach 3% yoy.
Second, wage growth in the eurozone remains subdued, with little signs of a clear upward trend across a range of measures. Although the unemployment rate has dropped sharply in the eurozone, there might still be slack in the labour market. Labour supply in particular might be higher because of the high number of part-time workers that want to work full-time and due to the rising participation of – in particular – older people in the labour market. These factors could dampen any rise in wage growth going forward and suggest that there are downside risks to even our rather low estimates of core inflation going forward.