Energy Prices Will Remain Key Driver Of Eurozone’s Inflation, But ECB Won’t Quit

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The advances in inflation figures throughout the Eurozone will be a subject of debate in the coming weeks, not least because of its bigger-than-expected rise. An increase which has a common thread in the form of hikes in energy prices and, to a lesser extent, in food prices. This contrasts with greater stability in core inflation, which rose to an annual rate of 0.9% in December for the whole of the EMU.

The former figure is the main reference to take into account in the short-term, in line with the tone of the ECB’s latest statement which clarified that the central bank would abstract itself from the variations in general inflation if they considered them transitory and without implications for the mid-term outlook for price stability. According to Intermoney’s analysts:

The above-mentioned stability in core CPI in the EMU would support this idea, based on the moderate increase in the prices of services from an annual rate of 1.3% to 1.2%. This contrasts with the uptick in non-processed food prices (+3.3% annually) and the visible knock-on effect in energy prices (+8.1% annually). The tension in both these components will continue over the coming months, then, will start to abate at the start of the summer.

On the other hand, UBS’ experts now expect annual average inflation in the Eurozone to pick up from 0.2% in 2016 to 1.8% in 2017 (prev. 1.4%) and 1.7% in 2018 (prev. 1.8%).

Our updated inflation forecast is now well above the ECB staff macro projection published in December, which had HICP at just 1.3% in 2017 and 1.5% in 2018.

Therefore, they do believe, however, that the ECB will have to revise its projection markedly upwards when it releases new forecasts on 9 March.

The pattern for France and German consumer price inflation was exactly the same that described above: the January increase was driven primarily by energy prices and food prices.

French inflation accelerated sharply by 1.6% with non-processed food prices raising 8.7% and energy 10%, both on a year base.

German consumer price inflation rose to 1.9% y/y in January. Specifically, energy price inflation rose to 5.8% y/y (after 2.5%) and food prices increased 3.2% y/y after 2.5%.

For UBS’ analysts energy price base effects will continue to be a key driver of inflation in the next few months with headline inflation remaining volatile around 2% until early spring, before moderating somewhat.

Given that the weight of energy in the German basket is slightly above the Eurozone average, these base effects could be slightly more pronounced in Germany.

The key unknown is core inflation, a fundamental driver of which are housing costs. These have been increasing for a while in Germany and have the largest weight in the HICP (21.6%). As house prices continue to rise, further upticks in rental inflation are a clear upside risk going forward. A more indirect underlying driver of inflation, which is only gradually picking up, is wage growth. As said by UBS:

We have long argued that the labour market is very tight – with unemployment rates at record lows, vacancies at record highs and increasing strike activity – providing a basis for an acceleration of wages going forward (see Germany: Signs of rising wage and price pressures). Higher headline inflation in itself could also be one additional trigger for higher wage settlements as unions adapt their inflation expectations upwards.

The figures out of Spain did not go off script, but given the much bigger-than-expected increase in the January inflation rate to 3.0%, a more detailed analysis is needed, Intermoney’s experts add.

The preliminary note on Spanish consumer prices did not provide much information but it was sufficient to confirm that the sharp rise was due, mainly, to the increase in electricity and fuel prices (gasoil and petrol).The base effect linked to the rises in oil prices was already discounted to a large extent, although this may be greater than initially expected and explain over 1.0 pp of the increase in our inflation. That said, the differentiating factor in the figure would come from the sharp advance in electricity prices.

According to figures from Red Eléctrica, the voluntary price of electricity for the small consumer has risen by almost 40% year-on-year. Then it was energy which was the main reason for the big upwards deviation in the inflation figures with regard to expectations. As Intermoney point:

This is something which will continue over the coming months, prompting us to revise our CPI forecast for Spain upwards to 1.9% for 2017, a year in which we think this variable will decrease.

The exceptional situation in the electricity market will start to lose impetus, while we see glimpses of a limit on the rise in crude prices which will end the year comparing with higher levels of prices. This will allow Spain’s CPI rate to stand at 1.4% in the final part of the year.