Euro Macro: Inflation distorted by Covid-19; core rate seriously over-estimated in June – Spain and Germany published June inflation data yesterday. Spain’s HICP inflation increased to -0.3% yoy, up from -0.9% in May, while Germany’s rate rose to 0.8% from 0.5%. According to the written statement by Spain’s statistical bureau INE and the detailed data for Germany’s main regions, energy prices had a significant upward impact on headline inflation in June, whereas food prices had a downward impact. With regards to core inflation, unfortunately, the data are seriously distorted by Covid-19. Indeed, due to lockdowns some services were unavailable for consumption and price data could not be collected. These are, for example, restaurant, bar and cafeteria services, accommodation services (campsites, hotels, apartments), flights, and travel packages. These had a total weight of around 13% in the HICP index in June, according to INE. In close cooperation with Eurostat, all the national statistical bureaus of the eurozone member states have agreed on a number of changes in the collection of price data (e.g. to a larger extent based on information from the internet) and have also agreed on some changes in the calculation of inflation rates. They have decided to keep all the weights in the original HICP index unchanged.
With regards to the prices that could not be collected, they have estimated the data in such a way that the impact on the yoy change in the price was as limited as possible. In practice this means that in the month of June, the core inflation rate was probably seriously over-estimated. For instance, in Germany the price of package holidays jumped by 18.6% mom in June 2019, and the assumption that, their yoy rate of change remained roughly unchanged to pre-Covid levels (around -3.0% yoy) implies that they had an upward impact on core-inflation of around 0.75pps in June 2020. So if we instead assume that the price of package holidays remained unchanged on a monthly basis, all else the same, total yoy inflation in Germany would have been close to zero in June.
Eurozone core inflation is set to plummet in the coming months. We judge that once the prices for items that have been most impacted by the Covid-19 crisis can be collected, they will show significant disinflation. As shown above in the case of German package holidays, we should see sizeable downward effects. Meanwhile, the cut in Germany’s VAT rate could reduce HICP inflation by two percentage points in Germany, which would drag the eurozone average down by 0.6 percentage points. More fundamentally, the crisis is leading to a large build-up of spare capacity, not least in the labour market where we expect the unemployment rate to soar. This is likely to see wage growth falling sharply, while pricing power will also diminish. Finally, the fall in inflation expectations to very low levels will also lead to more conservative price and wage-setting behaviour. (Aline Schuiling & Nick Kounis)