Core inflation surprised on the upside but not the
first sign of higher underlying price pressure
Pernille Bomholdt Henneberg
Chief Analyst
+45 45 13 20 21/+44 20 7410 8157
[email protected]
2 May 2017
Investment Research
www.danskemarketsequities.com
Important disclosures and certifications are contained from page 18 of this report.
Core inflation surprised on the upside but this is not the first sign
of higher underlying price pressure
Euro area inflation increased to 1.9% y/y in April from 1.5% y/y in March while core inflation
jumped to 1.2% y/y from 0.7% y/y, thereby reaching the highest level in four years. The higher
core inflation reflected higher service price inflation, which rose to 1.8% y/y from 1.0% y/y,
while non-energy industrial goods price inflation remained subdued at 0.3% y/y.
The question remains whether the higher service price inflation reflects a rise in underlying
price pressure, which would change the ECB’s monetary policy stance. Based on our
calculations, a very large part of the rise in service price inflation is due to the early Easter last
year, which is also reflected in the details about the German CPI inflation. Here, package
holidays added 0.9pp to HICP service price inflation in April, up from a drag of 0.6pp in March.
As German HICP accounts for 28% of euro area inflation, 0.4pp of the 0.8pp rise in euro area
service price inflation is due to German package holidays.
Among the remaining components of service price inflation we see few signs that the
underlying price pressure has started to pick up. The largest component of service price
inflation is recreation and personal care excluding package holidays. This figure was still
hovering around a historically low level in March, likely reflecting the lack of underlying price
pressure. On the other hand, the higher oil price has indirectly supported service price inflation
through transport prices and this likely also contributed to the higher figure in April. However,
as the oil price has stabilised, the indirect support should start fading in H2 17 given that the
underlying price pressure is still subdued as we expect.
(The euro area inflation details for April are released 17 May).
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The ECB should still extend its QE purchases but we now expect a
slower pace in 2018
The higher service price inflation is clearly good news for the ECB, but given that much of the
rise seems to be due to the early Easter last year and is not reflecting a rise in underlying price
pressure, we stick to our view that the ECB will continue its QE purchases into 2018.
However, after having looked into the inflation details and revised our core inflation forecast
slightly upwards, we now expect the ECB to reduce its purchases to EUR40bn per month
starting from January 2018 and continuing for at least six months. In our view, it is still
premature to discuss rate hikes from the ECB.
Ahead of the next ECB meeting in June, the inflation figure for May will be released, which will
be crucial for whether the ECB will change its communication in a more hawkish direction
and whether it will change its forward guidance. Draghi recently said that ‘before making any
alterations to the components of our stance – interest rates, asset purchases and forward
guidance – we still need to build sufficient confidence that inflation will indeed converge to our
aim’. We expect a decline in core inflation to 1.0% in May but this is higher than seen recently
and should support a more hawkish communication from the ECB at the meeting in June.
Following the April figure, we have revised our core inflation forecast up to 1.0% in 2017
from 0.9%, which is still a bit lower than the ECB’s forecast of 1.1%. In our view, the ECB is too
optimistic on the wage outlook and we believe slack in the labour market, particularly in the
periphery countries, will keep wage growth and core inflation subdued during this year.
Additionally, the ECB’s projection that core inflation will exceed its historical average of 1.4%
already next year, is in our view very optimistic and the ECB should eventually lower it.
2
Highest core inflation in four years – headline close to 2% target
Highest euro area core inflation in four years
Headline and core inflation should go lower
Source: Eurostat, Danske Bank Markets
Source: Eurostat, Danske Bank Markets
3
Higher core inflation could reflect rising underlying price pressure
Core inflation set to rise as output gap closes
Service price inflation dependent on labour
Wage growth remains subdued
– it could be supported by the
rise in actual inflation, but we
still believe there is too much
slack in the labour market for
much higher wage growth
Source: ECB, European Commission, Eurostat, IMF, OECD, Danske Bank Markets
Source: ECB, Eurostat, Danske Bank Markets
4
Core inflation excluding package holidays trended down recently
Core inflation ex package holidays downtrend
Package holidays very volatile around Easter
Core inflation in April was at the highest level
in four years, but excluding the impact from
package holidays the rise in core inflation
should be much more modest and followed
after a period of a downward trend.
Source: ECB, European Commission, Eurostat, IMF, OECD, Danske Bank Markets
Source: ECB, Eurostat, Danske Bank Markets
5
Package holidays add volatility to service price inflation
German package holidays very high in April
German package holidays large contribution
In Germany, package holidays has a weight
of 3.8% in total HICP inflation. As German
service price inflation has a weight of 46.1%,
package holidays had a positive contribution
to service price inflation of 0.9pp in April
after dragging down by 0.6pp in March*.
Source: Eurostat, Statistisches Bundesamt, Danske Bank Markets
Source: Eurostat, Statistisches Bundesamt, Danske Bank Markets
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What are the other drivers of service price inflation?
Service price inflation’s six subcomponents
Core inflation driven by services and NEIG
Recreation and
pers. care
HICP w.:
11.5%
Service w.:
25.7%
Services
HICP weight:
Core weight:
Housing
Miscellaneous
HICP w.:
10.7%
Service w.: 24.0%
HICP w.:
8.2%
Service w.: 18.4%
7.3%
16.4%
Package tours
and acc.
HICP w.:
3.5%
Service w.: 7.9%
HICP w.:
Service w.:
Semi durables
HICP w.:
10.1%
NEIG w.:
38.4%
Durables
HICP w.:
8.5%
NEIG w.:
32.2%
Non-durables
HICP w.:
7.8%
NEIG w.:
29.8%
44.6%
62.8%
Transport
HICP w.:
Service w.:
Comunication
3.2%
7.2%
Core
70.9%
Non-energy ind. goods
HICP weight:
Core weight:
26.3%
37.1%
Source: Eurostat, Danske Bank Markets
Source: Eurostat, Danske Bank Markets
7
The largest component of core inflation is affected by GDP growth
Closing output gap supports core inflation
Simple model points to higher inflation
Recreation and personal care is
the largest component in service
price inflation. In the beginning of
2017, the figure balanced around
a historically low level likely
reflecting lack of an upward trend
in underlying prices.
Source: Eurostat, Danske Bank Markets
Source: Eurostat, Danske Bank Markets
8
Rental for housing is partly affected by cost of borrowing
Low rates imply low housing inflation
Source: Eurostat, Danske Bank Markets
Simple model points to low housing inflation
Source: Eurostat, Danske Bank Markets
9
Service prices are also affected by the oil price
Inflation in transport services affected by oil
Higher wage growth within transportation
The higher oil price indirectly supports
service price inflation through transport
prices., but the stabilisation in the oil
price should imply the impact will fade.
Source: Eurostat, Danske Bank Markets
Source: Eurostat, Danske Bank Markets
10
Inflation in communication should remain a drag
Inflation in communication to remain a drag
Source: Eurostat, Danske Bank Markets
Miscellaneous services inflation lower in 17
Source: Eurostat, Danske Bank Markets
11
Non-energy industrial goods price inflation affected by energy
NEIG: Durables decline, non-durables very low
Source: Eurostat, Danske Bank Markets
The oil price has an indirect impact on NEIG
Source: Bloomberg, Eurostat, Danske Bank Markets
12
The euro has not weakened enough to support core inflation
Support from weaker euro is still fading
Source: Eurostat, Danske Bank Markets
Semi-durable goods prices lag durable goods
Source: Eurostat, Danske Bank Markets
13
Food and energy price inflation should continue to fade
Energy prices following the oil price increase
Unprocessed food price inflation declining
The stabilisation in the oil
price implies energy price
inflation will trend lower in
coming months.
Source: Bloomberg, Eurostat, Danske Bank Markets
Food price inflation was
supported by cold weather in
the Winter months and is
now correcting.
Source: Eurostat, Danske Bank Markets
14
ECB’s longer-term core inflation forecast still very optimistic
ECB expects high inflation due to rising core
ECB’s long core forecast still very optimistic
The ECB’s inflation forecast will
only materialise if core inflation
rises considerably above its
historical average of 1.4%.
Source: ECB, Eurostat, Danske Bank Markets
Source: ECB, Danske Bank Markets
15
ECB’s wage forecast still looks hopeful
Philips curve: ECB’s wage forecast is hopeful
Very large unemployment gap in the periphery
ECB 2019
Wages: 2.4%
Unemp: 8.4%
ECB 2018
Wages: 2.1%
Unemp: 8.9%
ECB 2017
Wages: 1.8%
Unemp: 9.4%
ECB 2016
Wages: 1.3%
Unemp: 10.0%
Source: ECB, European Commission, Eurostat, Danske Bank Markets
Source: ECB, European Commission, Eurostat, Danske Bank Markets
16
The market still does not believe in higher inflation from the ECB
ECB very optimistic compared with markets
Inflation expectations at QE announced levels
2.00%
1.50%
1.00%
0.50%
0.00%
We forecast inflation at 1.1%
in 2018 close to the current
market pricing but below the
ECB's forecast of 1.6%
-0.50%
-1.00%
Dec-13
Dec-14
Dec-15
Dec-16
Dec-17
Dec-18
HICP inflation
Market pricing
ECB inflation forecast (Sep-16)
Danske inflation forecast
Source: Bloomberg, ECB, Eurostat, Danske Bank Markets
Dec-19
Source: Bloomberg, ECB, Danske Bank Markets
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Disclosures
This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske Bank’). The author of the research report is Pernille
Bomholdt Henneberg, Chief Analyst.
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