Investment Research General Market Conditions 17 July 2014 Euro area deflation Inflation outlook Euro inflation remained very low at 0.5% in June and is still far below the ECB s target. In response, the ECB eased monetary policy with a package of measures in June. We believe the measures will gradually support inflation but it will take some time (see ECB Research: Implications of the ECB easing measures, 6 June, and ECB Research: Draghi reveals favourable TLTRO details, 4 July). We expect inflation to stay around current levels in Q3 but we see downside risk to our July forecast. Later this year, we forecast an increase to 0.9%, partly as higher global food prices are set to increase food consumer prices. When the impact of the ECB s policy kicks in and the recovery gains momentum higher wage growth should support inflation. Overall, we expect inflation to be 0.7% in 2014, increasing to 1.1% in 2015. The low inflation is not contradicting stronger growth in the euro area. Lower commodity prices have increased purchasing power and real wage growth is positive. This is a clear improvement from the declines in real wages in 2011-12. However, the negative impact of the exchange rate on inflation also drags down GDP growth. Deflation index In Danske Bank s Euro Area Deflation Index, all countries have a score lower than zero. The euro area score has declined to -6, although inflation was unchanged in June. The decline came mainly as nominal wage growth declined to 1.3% in Q1. The scores of the core countries are low but overall are held up by activity indicators. The German score remains negative despite an increase in inflation of 4pp. The Netherlands has the lowest score at -8, as inflation excluding taxes is at the deflation limit. The periphery countries are at the low end of the index and inflation is set to remain low as high unemployment limits wage pressure. This is partly a result of an adaptation of competitiveness, which is necessary to restore sustainable economic growth. Senior Analyst Pernille Bomholdt Nielsen +45 45 13 20 21 perni@danskebank.dk Danske Bank s Euro Area Deflation Index Note: Sorted by Danske Bank s Deflation Index, which is a weighted average of the indicators in the table. * A standardised industrial confidence indicator is used instead of PMI ** GDP and wages are not seasonally adjusted Important disclosures and certifications are contained from page 10 of this report. www.danskeresearch.com
Inflation outlook details The ECB s easing measures should put upward pressure on inflation through stronger economic activity and a weakening of the exchange rate. Based on the OECD s new global model, the negative impact of a weaker currency on inflation is set to be reduced by 0.15pp. This reflects improved price competitiveness and higher imported inflation. Core inflation increased slightly to 0.8% in June, up from 0.7% in May, and looking ahead we expect a gradual increase to 1.1% in Q4 14. The modest increase reflects weak price pressure from the labour market, where the large amount of slack is also likely to limit wage pressure when the recovery strengthens further. During the crisis, the shortterm unemployment rate has been a better indicator of wage growth than the total unemployment rate. Despite it declining recently, it points to higher wage growth. Inflation in food prices decreased further to -0.2% in June and is at the lowest rate in more than four years. We expect the increase in global food prices at the beginning of 2014 to put upward pressure on consumer food prices. The very first sign was seen in June, when the monthly change was 0% after being -0.1% for four months. Usually there is lag of three quarters, so, in our view, we should see the impact in Q4. However, we believe the spillover to food consumer prices is likely to be smaller than previously due to weak price pressure. Energy price inflation was 0.1% in June but we expect it to decline below zero again as the oil price has declined in July. Looking ahead, the oil price could decline further, as supply is boosted by new technology to make the most of shale formations, while demand is slowing as growth in China is less energy intensive. Lower wage growth despite a lower unemployment rate Short-term unemployment a better indicator during the crisis Source: ECB, Macrobond Financial, Danske Bank Markets Source: ECB, Macrobond Financial, Danske Bank Markets Smaller negative impact of weaker euro on inflation 5 3 1-1 -3-5 -7 %, OECD, Danske Bank Markets %-point 2010 2011 2012 2013 2014 2015 2016 Average annual appreciation/depreciation (lhs) Aggregate effect on inflation (weaker euro) (rhs) Aggregate effect on inflation (unchanged euro) (rhs) 0.5 0.3 0.1-0.1-0.3-0.5-0.7 Low inflation does not contradict stronger growth 2 17 July 2014 www.danskeresearch.com
Euro area We expect inflation to remain around the current level until Q4 14 The decline in euro inflation since September 2011 is due mainly to lower energy and food price inflation 1.0 0.0-1.0-2.0-3.0-4.0 Euro Germany France Spain Italy 1.0 0.0-1.0-2.0-3.0-4.0 Energy Food Industrial goods Services Taxes HICP, Danske Bank Markets, Danske Bank Markets Inflation in energy prices set to remain below zero Negative contribution from commodity prices in 2014, Danske Bank Markets Food price inflation set to pick up on higher global food prices Our food price inflation model points to higher inflation in Q4 14 Nominal wage growth lower in Q1 and it should stay modest......but real wage growth is still high due to low inflation 3 17 July 2014 www.danskeresearch.com
Germany Inflation rose to 1.0% in June from 0.6% in May Food price inflation has declined considerably lately Almost no impact of taxes recently Positive nominal (and real) wage growth Financial France French inflation is well below target but core inflation is higher Very low energy and food price inflation Higher VAT rate in January pushes inflation upwards Positive nominal wage growth but high unemployment rate Financial 4 17 July 2014 www.danskeresearch.com
Italy Inflation down at 0.2% but excluding taxes Italy has deflation Negative food and energy price inflation VAT hike in October pushes inflation up Unemployment rate shows first signs of stabilisation Financial Spain Inflation remains around deflation limit Positive energy price inflation but negative food price inflation Impact of tax hikes fell out in 2013 Nominal wage growth was positive in Q4 Financial 5 17 July 2014 www.danskeresearch.com
The Netherlands Inflation very close to the deflation limit Inflation in food prices below zero, energy price inflation above Excluding taxes, the Netherlands was at the deflation limit Positive but low wage growth and high unemployment rate Belgium Inflation remains relatively close to 1%, core close to 2% Decline in headline a result of lower food and energy prices Taxes have resulted in lower inflation recently Nominal (and real) wage growth above zero 6 17 July 2014 www.danskeresearch.com
Austria Inflation remains around 1.5% and has increased recently Modest downward movement in food price inflation Taxes have almost not affected inflation since end-2011 Wage growth has declined as suggested by unemployment Finland Inflation at 1.1% in June, core inflation declined to 1.3% Increase in inflation in food prices in June Inflation is held up due to taxes Unemployment rate increases and wages trend downwards 7 17 July 2014 www.danskeresearch.com
Greece Deflation at 1.5% in June and less negative than in May Historically low inflation in food prices Taxes affect inflation negatively (HICP excluding taxes -0.6%) Negative nominal wage growth but it stabilises Portugal Portugal remains in deflation, core inflation above zero Negative food price inflation in June Fall in inflation at beginning of 2013 due to taxes The unemployment rate has started to decline 8 17 July 2014 www.danskeresearch.com
Ireland Inflation has increased to 0.5% after behind around 0% Negative food price inflation but positive energy price inflation The unemployment rate continues to decline 9 17 July 2014 www.danskeresearch.com
Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S ( Danske Bank ). The author of this research report is Pernille Bomholdt Nielsen, Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in this research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts rules of ethics and the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of highquality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant assumptions, are stated throughout the text. Date of first publication See the front page of this research report for the date of first publication. General disclaimer This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options, warrants, rights or other interests with respect to any such financial instruments) ( Relevant Financial Instruments ). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report. The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change and Danske Bank does not undertake to notify any recipient of this research report of any such change nor of any other changes related to the information provided in this research report. 10 17 July 2014 www.danskeresearch.com
This research report is not intended for retail customers in the United Kingdom or the United States. This research report is protected by copyright and is intended solely for the designated addressee. It may not be reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank s prior written consent. Disclaimer related to distribution in the United States This research report is distributed in the United States by Danske Markets Inc., a U.S. registered broker-dealer and subsidiary of Danske Bank, pursuant to SEC Rule 15a-6 and related interpretations issued by the U.S. Securities and Exchange Commission. The research report is intended for distribution in the United States solely to U.S. institutional investors as defined in SEC Rule 15a-6. Danske Markets Inc. accepts responsibility for this research report in connection with distribution in the United States solely to U.S. institutional investors. Danske Bank is not subject to U.S. rules with regard to the preparation of research reports and the independence of research analysts. In addition, the research analysts of Danske Bank who have prepared this research report are not registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirements of a non-u.s. jurisdiction. Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant Financial Instrument may do so only by contacting Danske Markets Inc. directly and should be aware that investing in non- U.S. financial instruments may entail certain risks. Financial instruments of non-u.s. issuers may not be registered with the U.S. Securities and Exchange Commission and may not be subject to the reporting and auditing standards of the U.S. Securities and Exchange Commission. 11 17 July 2014 www.danskeresearch.com