EUROZONE INFLATION: AN EVEN STRONGER CASE FOR ECB TO ACT

Very subdued inflation: Despite the record-breaking rebound of the Eurozone economy in the summer months from the mega-recession in March/April, inflation pressures remained very subdued in October, that is just before major parts of Europe tightened restrictions or imposed new lockdowns to contain the second wave of corona infections. This is no surprise as Eurozone GDP still fell 4.3% short of its pre-pandemic peak in Q4 2019. Although small parts of the economy’s capacity may have been lost for good, the even bigger hit to demand than to supply still translates into more idle resources – think of the rise in official unemployment plus those that have left the labour force altogether “discouraged” – as the ECB has put it – of actually finding work if they look for it. Low capacity utilisation and reduced demand for labour usually keep a lid on prices. The current high degree of spare resources has pushed core inflation to a mere 0.2% yoy in October (see Chart 1). Core inflation, which strips out the volatile components (food and energy) and only includes price gains of non-energy industrial goods and services, thus remained at the lowest ever since the beginning of the euro in 1999. On the headline measure, prices fell by 0.3% yoy in October, unchanged from September. Eurostat confirmed its preliminary estimate of Eurozone inflation.

The worse-than-expected second wave of infections and restrictions will add to the disinflationary forces that have been around since spring. Energy prices fell by 8.2% yoy in October and shaved off 0.8ppt from the headline rate (see Chart 2). The energy component looks set to reduce the headline rate again in the months ahead as pump prices have fallen by more than 2% over the past two weeks. This effect could amount to possibly up to 0.2ppt more in January than in October if energy prices were to remain at current levels. Transport services prices have followed energy prices down with a lag, falling by 0.9% yoy in October (see Chart 3). Lockdowns and continued travel restrictions weigh on demand and prices in the sector. As in March, prices for unprocessed food have picked up as consumers started to make big food storage purchases in response to surging infections and restrictions. After the big distortion over the summer months the (semi-durable) retail sector – think clothing and footwear – may yet again contribute to some volatility in the headline and core rate in the months ahead. Underlying price pressures – non-energy industrial goods and services in general – remain low. Prices for non-energy industrial goods fell by 0.1% yoy in October. Service prices still rose, but the 0.4 yoy rate in October is an all-time low for Eurozone services inflation. The longer authorities have to maintain restrictions and the more – domestic as well as foreign – demand is hit relative to supply in the winter months, the more underlying price pressures will head further south.

An even stronger case for the ECB to act: Today’s publication of Eurozone inflation was not the last before the ECB will hold its 10 December meeting. Eurostat releases its preliminary estimate for inflation in November on 1 December. Headline inflation has averaged 0% yoy in Q3. The average of the months October to December will likely be -0.3% yoy or lower. Both undershoot the ECB’s current projections from early September of 0.1% and -0.2%, respectively. Besides nudging down its near-term outlook, the ECB will probably also lower its medium-term projections. In response to – among other things – the downgrade in its projections, we expect the ECB to announce a substantial package at its 10 December meeting – see here and here for what we currently expect.

Florian Hense

Economist

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