Eurozone - Inflationary pressures are melting away

Eurozone GDP probably stagnated for the sixth consecutive quarter in 2024Q1. Our monthly GDP tracker, consisting of retail sales, new car registrations, industrial production, as well as surveys gauging activity in the services sector, suggests that GDP was roughly unchanged in January-February. Recent indicators for global industry and trade have signalled a bottoming out, suggesting that the EZ industrial sector and exports should pick up in the coming months. On the other hand, final domestic spending is expected to remain subdued for a while, with fiscal policy tightening and the still high level of interest rates dampening consumption and investment. Also, the deterioration in labour market conditions that has resulted from the ongoing economic stagnation is expected to have a downward impact on wage growth and private consumption this year. Following economic stagnation in Q1, we expect GDP growth to pick up somewhat during the rest of the year, but remain below the trend rate.

Disinflation has continued in the first months of 2024. Headline inflation declined to 2.6% in February, down from 2.8% in January and core inflation decreased to 3.1% from 3.3%. The details show that since the end of 2023, the largest drops were in food and non-energy industrial goods. Services inflation stabilised in January and February 2024 (at 4.0%) and energy price inflation increased, although it remained negative (-3.7% yoy in February). Services is by far the biggest contributor to total inflation. Services inflation is mainly domestically driven and wage growth has a relatively big impact on price changes. Therefore, easing wage growth will be an important condition for services price inflation to ease. As we explain in a recent note (see here) wage growth in the eurozone has already peaked and we expect it to continue to decline in the coming quarters. Moreover, ongoing weak (services) consumption growth is limiting the room for price rises. All in all, we expect headline and core inflation to continue to decline in the coming months, approaching the ECB’s 2% target around the middle of the year.

The ECB kept its communication on monetary policy unchanged in its March policy statement, however ECB staff made downward revisions to their inflation forecasts, which lays the groundwork for the start of a monetary easing cycle in the coming months. In the press conference, ECB President Christine Lagarde suggested that June would most likely be the starting point for rate cuts. Despite the downward revisions, President Lagarde said that recent data made the Governing Council more confident on inflation but not yet ‘sufficiently confident’. Although the ECB was seeing evidence of slowing underlying inflation, it wanted to see more convincing data of slowing domestic inflationary pressures, especially on wage growth and services inflation. In terms of the data flow on these topics, she asserted that ‘we will know a little more in April and a lot more in June’. This is not a very subtle hint that the ECB will likely wait until June before cutting rates.