EU CPI
Fundamentals Update as at 26 November 2013 by Lorenzo Beriozza
October HICP inflation was the lowest in four years. On a quarterly basis, it looks as if price levels will fall in Q4. Declines are rare and usually followed by a reversal the following quarter. Overall, we do not think the factors that pushed down prices last month are going to be persistent. 0.7% inflation should be the trough in the cycle.
But risks on the downside are likely to be high and rendered more pertinent given the low starting point. Risks can come from lower than expected energy and food prices; less pass through than expected from VAT increases; and/or a relapse of the euro area economy back into recession. That said, in the medium to longer term, different capacity utilisation and inflation expectations measures suggest that inflation should start to climb modestly from here, as long as the recovery continues.
A broad range of factors point to low, but not lower inflation in the euro area. And in spite of all the talk about risks of sharper disinflation, markets seem not to have priced much of it in, in the short term at least. Many forecasts to Q1 usually show lower prints than the markets’ current pricing. It is understandable the ECB explains the “prolonged period of low inflation, to be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on”. Other things being equal, inflation should not push the ECB’s hand further.
And there are a couple of positives as well. First, it is not all “bad” low inflation. Downside pressures are coming from food and energy and lower taxes. This will allow the euro area consumer to “buy more stuff”, as ECB President Draghi put it. The fall in the HICP in Q4 should, indeed, boost real disposable income growth. Second, the need for higher inflation in Germany remains strong. That said, inflation in the periphery is likely to be close to – if not at – its trough. This will lessen the acute downward pressures so far recorded.
Source: Credit Suisse
