Global Daily – Underlying inflationary pressures weak in the eurozone

Looking at the components, service sector inflation was the driver behind the fall (down to 0.9% from 1.3%). The decline in service sector inflation can be entirely explained by prices of items related to travel (flights, accommodation and package holidays), with the drag on service sector inflation intensifying to 0.4 percentage points from 0.1 percentage point in March. The drag from those items peaked in the autumn of last year and subsequently eased, also helped by a re-weighting of those items in the HICP basket because of the collapse in travel spending. The reason behind the recent intensification of price falls for holidays is unclear, given that these sectors have remained weak during the entire period.

Looking forward, there are some potential sources of upward pressure for core inflation. There is a base effect from last year’s German VAT cut, which should push up inflation this summer. In addition, prices in some sectors most impacted by the restrictions, which have fallen sharply, could see some normalisation. The holiday-related items discussed above are a case in point. Having said that, we would not expect this to be on a very broad scale, as seen recently with the surge in US core inflation. This is because inflation in some of the service sectors that should have been most affected by the lockdown has actually not moved that much. This may reflect that statistics agencies across Europe have been imputing these prices because collecting data is difficult during lockdown. In April, this was the case for 21% of the service sector price basket. We suspect that the imputation method may have meant that these prices have been over-estimated. So neither the downward nor the potential subsequent upward adjustment in service sector prices would show up in the official data.

More fundamentally, we think core inflation will settle at very low levels in 2022 and 2023.  Despite the economic recovery, we will likely remain in an environment of substantial economic slack. This is likely to also become increasingly evident in the headline unemployment figures in the coming months. As we noted in yesterday’s edition of this publication, the combination of falling participation and wide-spread use of short-time work schemes means there is currently a great deal of hidden unemployment. So once some of the pandemic-driven volatility subsides from the numbers, we are likely to be facing a very familiar sight: inflation below the ECB’s price stability goal. (Nick Kounis)