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Eurozone: weak core inflation, until when?

The major economic figures on the eurozone that appeared this week merely repeated the trends we have seen year-to-date: growth is once again confirming its strength (GDP up 0.6% in Q3, with economic indicators staying positive for October), but is not helping core inflation(ex energy and food), which surprised to the downside (0.9% in October, after 1.1% in September).

 

Admittedly, this latest low for core inflation may have been caused by temporary factors (in Italy and Germany). Nonetheless, as the months go by, it has not managed to stay durably above the threshold of 1% per year.

 

Whence this apparent contradiction between strong growth and weak inflation, which has in fact affected most major developed countries, to varying degrees? Despite considerable analysis, the national statistics institutes, international organisations, and (even more relevantly for investors) central banks admit they do not have a definitive answer.

However, if we attempt to sum up their main assumptions, it would seem we can advance (though not really decide on) the following factors*:

-Cyclical factors, specifically the ongoing improvement in the labour market, should ultimately support inflation.

-However, due to trends in the labour market (the increase in part-time work and, in some countries, the decline in the participation rate), this support may come later than anticipated. In fact, the unemployment level at which upward pressure is exerted on wages seems lower than in the past.

-Because of other structural changes in the labour market (the transition from industry to services, the slowdown in productivity gains, and reforms more favourable to employers than employees), this acceleration in wages, even once we see it, could remain limited.

-Other structural factors less directly connected to the labour market (new technology and regulatory trends that make customers less captive to their suppliers) should also have a lasting (or even increasing) disinflationary influence.**

 

In the main, our core inflation scenario for 2019 takes the following into consideration: despite this year's downside surprises, we still think that the direction for the next few quarters will be upward, in view of the rapid improvement in the labour market (at just below 9%, the eurozone jobless has now fallen near its long-term average). However, the slope is expected to be very moderate. Even though it was recently lowered to 1.5%, the ECB's outlook for 2019 may still be too high. The prospect of even being able to reach the ECB's target ("below, but close to 2%") during this economic cycle, without the contribution of volatile components, seems to be more uncertain than ever.***

 

*See, for example, the debates on this topic by governors of the US Federal Reserve as covered in the Minutes of the September 2017 FOMC Meeting.

**Let us further add that the rapid changes in technology are also fuelling the debate over the fair measure of inflation. Indeed, certain economists are asserting that due to the emergence of new products and services, inflation is in reality even weaker than as currently measured.

***Note that a core inflation rate of 2% per year has only been seen in one monthly measurement (March 2008) during the latest economic cycle in the eurozone, in what could be called an "overheating" period.Core inflation above 2% has not been seen since 2002.

 

 

 

 

2017-11-03-graphe

 

 

PERRIER Tristan , CFA, Strategy and Economic Research at Amundi
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Eurozone: weak core inflation, until when?
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