More hope than conviction for euro zone inflation rebound

April 29, 2014

ECB President Mario Draghi has a friend in euro zone economists of late. They tend to line up and take his view, at least when it comes to forecasting inflation.

There is no serious risk of deflation in the euro zone, nearly every one of them says, and from here onward, euro zone inflation will only be higher than the March trough of 0.5 percent.

That is the line you need to take if you are not yet willing to say that the central bank, which has chopped policy rates all the way to the floor, is more likely than not to print money to get out of the mess.

The ECB’s mandate is very narrow, and very clear. It aims for price stability in the form of inflation just below 2 percent.

The main reason for the fall from 2.5 percent nearly two years ago to 0.5 percent now is a drop in energy prices. But that doesn’t explain where inflation will go from here.

Jessica Hinds, European economist at Capital Economics, writes that the European Commission’s latest survey of consumers does nothing to give the impression inflation is about to set on a different path:

Worryingly, consumers’ expectations of inflation weakened again in April and are now at their lowest since March 2010, echoing the message from the April PMI survey data that the risk of deflation in the euro zone has not diminished.

The latest set of inflation data from Germany, the euro zone’s strongest economy and therefore the most likely one to generate any kind of meaningful price pressure, suggest that even there, it is still disconcertingly low.


German HICP rose to just 1.1 percent, from 0.9 percent, well below the 1.3 percent consensus. That suggests that the Reuters consensus forecast for a rise in April flash euro zone inflation to 0.8 percent, which is based loosely on a less negative comparison with last year’s steep falls in energy and food prices, may be too high.

Meanwhile all around Germany are signs of even weaker price pressures. The most torpid of economies in the euro zone, particularly Greece, are already reporting falling prices on a year earlier.

Given the importance of Germany’s contribution to the euro zone economy, it would be difficult to conclude through any amount of statistical explanation that a slight change in a very weak inflation rate there is pointing to the end of a bout of disinflation in Europe.

Indeed, much of the hope for a pickup in price pressures must necessarily ride on a strong contribution from its largest and fastest-growing economy, and particularly, wage inflation, which the ECB has watched closely since it came into existence.

Christian Schulz, economist at Berenberg, explains his hope for higher euro zone inflation in coming months:

 … particularly in Germany, unemployment is so low and job growth so strong at the moment that some wage inflation is likely to come through. And with consumption already rising and probably rising a bit faster throughout the year retail prices are likely to increase as well.

In the latest set of Reuters polls on the long-term outlook for Europe, taken two weeks ago, the highest average quarterly forecast for euro zone inflation collected from any contributor was 1.8 percent, and not until Q1 2015. The lowest was 0.6 percent.

With unemployment still endemic across the euro zone – in Spain it is now nearly 26 percent – how could anyone really be convinced a wage-generated rebound in inflation is just around the corner?

— reporting by Sumanta Dey and Anu Bararia

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