Global Daily – Drop in core inflation adds to ECB uncertainty

by: Aline Schuiling , Bill Diviney

Euro Macro: Eurozone core inflation drops to well below 1% – The flash estimate for HICP inflation in the eurozone showed it declined from 1.3% in March to 1.2% in April. The break down in main components reveals that the decline was due to a drop in core inflation (inflation excluding food, energy, alcohol and tobacco), which fell to 0.7% in April, down from 1.0% in March. In contrast, both food price inflation and energy price inflation increased in April. The drop in core inflation was concentrated in services, with services price inflation dropping to 1.0% from 1.5%. In contrast, non-energy industrial goods inflation, which is closely linked to global price changes and the exchange rate, edged higher to 0.3% from 0.2%. Looking forward, we think that the largest part of the rise in services sector price inflation will be unwound in May, as the jump in April was mostly due to base effects in the prices of holiday trips and hotels and restaurants related to the early timing of Easter (this year in March, last year in April). Working in the other direction, however, we expect the inflation rate of non-energy industrial goods to decline somewhat in the coming months due to the delayed impact of the euro appreciation in the second half of last year. On top of that, more fundamentally, the key driver of core inflation –wage growth – remains subdued given that there is still slack in the labour market. Our base line scenario is that core inflation will hover around the 0.9-1.0% level in the coming months. Subsequently, we expect it to rise slowly later in the year, but it should remain well below the ECB’s target throughout 2018 and 2019. The drop in core inflation will create uncertainty at the ECB about whether the upward trend it is forecasting for core inflation will materialise any time soon. Together with uncertainty about the macro outlook, it confirms that the ECB’s exit will be very slow. It will be a long goodbye. (Aline Schuiling)

US Macro: Disappointing productivity numbers, but investment still strong – Preliminary data showed productivity grew just 0.7% q/q saar in Q1, while unit labour costs grew 2.7% – a disappointing outturn for those expecting a productivity revival. Quarterly data are volatile, however, and on a four-quarter moving average basis, productivity growth remained at 1.3% yoy, with unit labour costs growing just 0.5%. Since unit labour costs are the main driver of core services inflation, this means we are unlikely to see significant inflationary pressure from the tight labour market in the near term. Further ahead, meanwhile, we continue to expect the recent pick-up in investment growth to drive higher productivity growth, which should keep a lid on unit labour cost growth even as wage growth accelerates. Indeed, investment grew strongly in Q1 at 4.1% q/q saar, even following a surge in Q4 17 of 8.6%, while leading indicators such as the ISM new orders index continue to point to strong investment growth over the coming quarters. While it is difficult to pinpoint the precise timing, the historical relationship suggests higher investment should ultimately lead to higher productivity growth. (Bill Diviney)