EMU core inflation boosted by early Easter?

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1 EMU core inflation boosted by early Easter? EMU CPI climbs out of negative territory After being negative for one month, euro zone headline inflation came out flat in March, beating the market consensus, which was looking for another negative figure. In March, euro zone CPI picked up from.2% Y/Y to.% Y/Y. Although encouraging, we doubt whether EMU headline inflation will be able to stay out of negative territory in the coming months. 4,% 3,% EMU CPI Inflation (Y/Y) EMU CPI ECB Target Following a sharp drop in February, euro zone headline inflation rebounded in March, rising from.2% Y/Y to.% Y/Y. Core inflation jumps higher too, but Looking at the details, the rebound in euro zone inflation is partially due to the recent increase in the oil price. Nevertheless, also core inflation picked up last month, from.8% Y/Y to 1.% Y/Y, reversing the February dip. Inflation in the services sector showed an encouraging rebound, to its highest level in almost two years. A closer look at the details suggests that the pick up might be related to the early timing of Easter. We are therefore cautious to see whether core inflation will reverse (part of) the increase next month. Also the number of product groups observing negative annual inflation dropped significantly in March (23% vs 28%), reversing part of the February uptick. It remains however below the recent low (19%) registered in January. The breakdown by country shows a very mixed picture. In five countries inflation accelerated compared with the month before, while it slowed in four and stabilized in two. Despite the uptick in inflation, a broad package of ECB measures in March and recent uptick in oil prices, marketbased measures of inflation expectations show little to no improvement. The ECB s actions only helped to temporarily stop the downtrend in market based measures of inflation expectations. In the meantime however, both the ECB s closely watched 5yr/5yr forward and 1yr inflation expectations derived from the swap market are again close to their lows, suggesting that markets have little hope that the ECB s measures will succeed in bringing inflation back to its 2% target over time. Also the IMF sounded pessimistic on EMU inflation longer term and expects headline CPI to reach only 1.7% in 221! Headline CPI to remain under pressure Euro zone inflation showed an encouraging rebound in March, climbing out of negative territory. While it was partially due to the (limited) increase in the oil price, also inflation in the services sector increased significantly. We believe however that part of this rebound is due to the early timing of Easter and might be partially be reversed in the coming months. In the coming months, the direction of headline inflation will depend on developments in the oil price, but negative base effects will keep every increase in the headline figure limited, at least in the first half of the year. Even a temporary return in negative territory is not excluded. Later this year, the economic recovery, ECB s stimulus measures, a recovery in the oil price and positive base effects will push inflation higher. Regarding core inflation, we see little upside near term as the recovery remains subdued, but neither expect a significant decline as there are no signs of second round effects. Joke Mertens, KBC Dealingroom P. 1

2 Special aggregates EMU Inflation Rates (Y/Y) CPI Goods vs Services 4,% 5,5% 4,5% 3,% 3,5% 2,5% 1,5%,5%,5% 1,5% 2,5% EMU CPI EMU Core CPI EMU CPI Goods EMU CPI Services After being negative for one month, Euro zone headline inflation was flat in March, supported by a limited rebound in energy prices. Also core inflation rebounded, to 1.% Y/Y, probably partially due to the early timing of Easter. Although energy prices rebounded in March, negative base effects pushed goods inflation further down. Encouragingly however, inflation in the services sector accelerated to 1.4% Y/Y, its highest level in almost two years. We believe however that this is at least partially due to the early timing of Easter and a payback is likely in April. 4,% 3,% CPI At Constant Tax Rate m/m y/y Core CPI (Ex. Food & Energy) 1,55% 1,3% CPI Ex. Energy 1,2% CPI Goods 1,84% 1,19% CPI Services,47% 1,37% CPI at Constant Tax Rate 1,22%,17% EMU CPI EMU CPI at Constant Tax Rate Over the previous years, governments took austerity measures including tax increases, which supported headline inflation. In March, inflation at constant tax rate picked up less than the headline rate, from.26% Y/Y to.17% Y/Y, below the headline inflation rate (% Y/Y). P. 2

3 Inflation by country Y/Y Change 1,5%,5%,5% 1,5%,1%,5%,5%,1%,15% Contribution to Y/Y change Y/Y change (month 1) Y/Y change Although euro area inflation picked up in March, the national data show a mixed picture. Inflation increased in five countries, slowed in four and stabilized in the two others of our selection of 11 countries. Five countries are observing negative inflation. The graph above shows the contribution of each member state to the flat EMU inflation rate (annual rates of growth multiplied by their weight in the EMU inflation reading). Spain is by far weighing the most on EMU headline inflation. Although Belgian s weight is quite small, the high rate of headline inflation in the country makes it the biggest positive contribution to the EMU Y/Y inflation rate. The increase in Belgian inflation is however mainly due to tax increases. Weight Y/Y Change (month 1) Y/Y Change (month) Contribution to Y/Y Change EMU CPI Inflation Y/Y 1,2% German CPI Inflation Y/Y,27744,2%,1%,3% French CPI Inflation Y/Y,2551,1%,1%,2% Italian CPI Inflation Y/Y,17662,2%,2%,4% Spanish CPI Inflation Y/Y,1219,12% Dutch CPI Inflation Y/Y,4953,3%,5%,2% Belgian CPI Inflation Y/Y,3585 1,1% 1,6%,6% Austrian CPI Inflation Y/Y,3338,6%,2% Greek CPI Inflation Y/Y,2572,1%,7%,2% Portuguese CPI Inflation Y/Y,2132,2%,5%,1% Finnish CPI Inflation Y/Y,1912,1% Irish CPI Inflation Y/Y,1357,2%,6%,1% P. 3

4 Inflation by product group 3,% 4,% Y/Y change,2%,1%,1%,2%,3%,4% Contribution to Y/Y change,5% The breakdown by sector shows that negative inflation is now entirely based in energy related sectors (transportation & housing, elect., gas ), which is an encouraging sign and indiates that downward price pressures are not broad based. Adding to the positive news, inflation in several categories (restaurants & hotels, recreation & culture, education ) is approaching 2%, but it is still to be seen whether this trend continues in the coming months. The graph above shows the contributions of product groups to the % Y/Y inflation rate (annual rates of growth multiplied by their weight in the EMU inflation reading). Only lower transportation prices and prices for housing, water, electricity & gas are weighing on the flat annual inflation rate, but elsewhere upward price pressures are starting to increase. Weight M/M change Y/Y change Contribution to Y/Y change CPI inflation 1 1,23%,5%,5% Food & Nonalcoholic beverages,1571,21%,61%,1% Alcoholic Beverages, Tobacco & Narcotics,44,6% 1,36%,5% Clothing & Footwear,634 15,81% Housing, water, elect, gas & other fuels,1632,2% 1,4%,23% Furnishings, Household equip. & maintenance,66,4%,5%,3% Health,436,1%,8%,3% Transport,1522,73% 3,19%,49% Communications,36,1%,1% Recreation & Culture,948 1,1% 1,91%,18% Education,15,1% 1,71%,2% Restaurants & Hotels,914,6% 1,92%,18% Miscellaneous Goods & Services,869,2%,8%,7% 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % CPI Breakdown by Sector % of negative Y/Y CPI vs positive Y/Y CPI 32% 26% 26% 27% 26% 27% 27% 19% 23% 24% 19% 28% 23% Negative Positive This graph represents the percentage of product groups with positive annual CPI rates (dark blue) versus negative CPI rates (light blue). After a sharp increase in February, the number of product groups observing negative annual inflation dropped significantly in March, from 28% to 23%, providing some hope that the March uptick was only a one off. P. 4

5 Forward-looking indicators PPI CPI Inflation Import Prices CPI Inflation 1 8,% 6,% 4,% 4,% 6,% 8,% 1 7,5% 2,5% 2,5% 7,5% 12,5% PPI Inflation EMU CPI Inflation EMU PPI inflation is often leading somewhat on CPI inflation. PPI inflation dropped sharply in February due to negative base effects and a further decline in oil prices. The recent increase in oil prices might however push PPI inflation higher from March onwards. EMU CPI Inflation Import Price Index The decline in import prices accelerated further in February, (from 4.3% Y/Y to 6.3% Y/Y) due to negative base effects and a further drop in oil prices. Also here, the downtrend might slow somewhat due to the rebound in the oil price, but it is tempered somewhat by the stronger euro. 3 EMU Inflation VS Official Forecasts 2,5 ECB Survey of Professional Forecasts Inflation Expectations 2, ,5 1,5 1 1,5,5 EMU Annual Inflation Y/Y EC ECB IMF OECD ECB Target EMU inflation was flat in 215, the slowest rate of inflation in the history of the currency union. According to the ECB s March staff forecasts, inflation is expected to pick up only marginally this year, to.1% Y/Y. The IMF expects EMU inflation to remain well below the 2% target even untill 221 (1.7% Y/Y). % Longer term Q1 215 Q4 215 Q1 216 ECB Target In the first quarter, ECB professional forecasters sharply downgraded their inflation forecasts for this year. Also for 219, inflation expectations were revised lower to 1.8% Y/Y, still below the ECB s target of below but close to 2%. For 216 and 217, forecasts were revised to.7% and 1.4% respectively versus 1% and 1.5% in Q Inflation Expectations from survey measures ,8 2,6 2,4 2,2 2 1,8 1,6 1,4 1,2 1 Inflation Expectations from Swap markets EC's Industrial Confidence Selling Price Expectations EC's Consumer Confidence Price Trends over Next 12 Months Survey measures of inflation expectations showed a mixed picture, but remain quite low. Firms selling price expectations picked up slightly in March, but consumers price expectations eased somewhat from its highest level since July last year. 1Yr Inflation Expectations Derived from Swap Market 5Yr 5Yr Forward EUR Inflation expectations derived from the swap market continue to hover around the lows. The recent rebound in the oil price failed to boost inflation expectations and also the ECB s actions in March had only a temporary effect. The ECB s closely watched 5yr/5yr forward rose after the ECB announced a broad package of new measures in March, but already reversed most of its gains. P. 5

6 Contacts Brussels Research (KBC) Global Sales Force Piet Lammens Brussels Peter Wuyts Corporate Desk Joke Mertens Institutional Desk Mathias van der Jeugt France Dublin Research London Austin Hughes Singapore Shawn Britton Prague Research (CSOB) Jan Cermak Prague Jan Bures Petr Baca Bratislava Research (CSOB) Marek Gabris Bratislava Budapest Research David Nemeth Budapest ALL OUR REPORTS ARE AVAILABLE ON This non exhaustive information is based on short term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice. P. 6