The balancing acts which are devised in Frankfurt oblige us to once again take a look at the present and future of inflation in the Eurozone. This is the reason why Intermoney’s analysts focus their analysis on the prices chain. “The ECB did this exercise and the conclusions favour the institution’s caution,” they explain.
The inflation data which will be released in the next few days throughout the EMU will be very important ahead of the upcoming ECB meeting. The central bank’s discourse will show off its difficult balancing act so that its more positive tone towards activity and the risk scenario coexists with a message tending towards upholding the perspectives for its asset purchasing programme. With regard to this last point, the house thinks “the reality is simple and in keeping with very progressive and measured actions”, with inflation current’s behaviour serving as the perfect excuse for justifying the ECB’s strategy.
After the uptick in production prices (IPRI) in the Eurozone to an annual 4.5% in February, our central bank carried out an interesting analysis of the prices chain which would reinforce its stance. Something which becomes more important at a time like this, characterised by volatility in prices’ indices and which, in fact, was actually confirmed by the slowdown in the EMU’s IPRI to an annual 3.9% in March. And this will be re-affirmed by the EMU CPI figure due to be released in the next few days. In May, this will slow to annual levels of 1.5%, in line with those reached in March.
The difference in calendar days between 2016 and 2017 has injected a huge injection of volatility into the inflation figures over the last few months and, now, “we have to focus on fundamentals“, analysts say. They add:
In the first place, we need to closely follow the behaviour of non-energy industrial goods given that these reflect pressures on the upside and the downside at the initial stage of the price chain. They are an important thermometer for future inflation, although in today’s world services hold the key. As as matter of fact, terciary sector prices account for 44.57% of the EMU CPI.
But let’s get back to non-energy industrial goods. The formation of their prices is exposed to local factors and other more global ones which filter through at different stages in the production chain, starting with those derived from raw materials.
In this case, we have to distinguish between energy prices and the rest, since the relationship of the latter is more direct and the impact of their progress over the last few months is indisputable.
Bloomberg’s index of non-energy raw materials rose nearly 18.5% from its January 2016 lows to the highs of last February, declining almost 5% since then. This is a situation which was amplified by the euro’s depreciation over the same period, which was around 4.5% based on the nominal exchange rates pondered by the weighting of the trading relations of the 38 main EMU partners. That said, as raw material prices weakened, the euro gained nearly 4% during the spring compared with the currencies of the main trading partners.
Later on, in the initial stages of the prices chain, we witnessed significant upside pressure at the start of 2017, which pushed eurozone intermediate goods’ prices to an annual 3.9% in March, reinforced by the indirect effect of energy. Transport costs are included in the products right from when they are just raw materials up until they arrive at the retailers as a final product. At the same time, the use of energy also plays an important role in the transformation process. Experts comments:
The correlation analysis carried out by the ECB flags that the production prices of intermediate goods industries reach their highest point of connection with the final prices of non-food industries (0,7) with an over six months’ lag. A relationship which would lead us to expect more from the IPRI in the coming months, although there are reasons to be cautious. The aforementioned improvement in the euro exchange rate, which we hope will last on average for the rest of the year, and the slowdown in raw materials’ prices, will begin to be reflected in the IPRI data. So the advance registered by intermediate goods will lose momentum.
The previous situation becomes important due to the existence of dampers as the production chain advances. These explain the temporary decoupling between the rises in basic and intermediate goods and in the final products. One of the most important dampers are the medium-term contracts signed with suppliers which usually establish conditions beforehand. So that means it is very important for the upside in intermediate goods to last for some time so that it can be transferred to the prices chain. Currently, the problem is that those big advances in intermediate goods may not last long enough to be transferred with any real momentum, and this would also end up being reflected in the contention of the consumer price index.
The same ECB analysts flag that the increase in import prices also played an important part in the CPI’s uptick at the start of the year, noting that the euro’s appreciation would ease this. They also talked about a link between industrial prices and final inflation to a similar one existing between intermediate and final industrial prices. The highest correlation between both variables would be 0,7 and there would be a lag of over a year.
In conclusion, Intermoney says that if we were to leave to one side the direct effect of energy on the prices indices, the links and, above all, the time lags existing between the advances in the prices’ chain, support the ECB’s prudent approach in this matter.
In fact, over a year could go by from the time a signficicant rise is noted in industrial goods up until it materialises in the CPI. This is a scenario which leads us in Intermoney to reaffirm our forecast for a declining CPI in the EMU during 2017, and a similar stable pattern in 2018, with figures along the same lines as this year.