Euro-area HICP inflation increased to 0.3% y/y in May from 0.0% y/y in April. The biggest surprise was an increase in core inflation to 0.9% y/y in May from 0.6% y/y in April (consensus 0.7% y/y).
The data today confirm that the euro area has exited deflation. It seems likely that headline inflation will increase above 1.5% y/y in January 2016.
The surprisingly higher core inflation followed as both service price inflation increased (around 60% of core inflation) and as inflation in non-energy industrial goods was higher (around 40% of core inflation). We look for core inflation around 1.0% y/y at the end of the year but we expect it to decline a bit again in May.
Service price inflation increased to 1.3% y/y in May from 1.0% y/y in March and April and is the highest since August 2014. The higher service price inflation could reflect higher wage pressure, as the unemployment rate has declined since mid-2013, but based on the German CPI inflation some of the increase seems to be the result of the volatile component 'package holidays'. This is likely to reflect some payback from previous months but as the component is very volatile, the increase could prove temporary and we expect lower service price inflation in June.
Inflation in non-energy industrial goods increased for the third month in a row to 0.3% y/y in May from 0.1% y/y in April. The trend higher is supported by the weaker euro and the higher oil price and should continue in coming months.
The drag from energy price inflation also continued to fade as energy price inflation was -5.0% y/y in May up from -5.8% y/y in April (it bottomed at -9.3% y/y in January). Energy price inflation should increase further and we expect it to turn positive in Q4. This partly reflects that we look for the oil price to continue higher this year. Added to this, base effects from the sharp decline in the oil price last year should also support energy price inflation at end-2015.
Food price inflation increased for the fourth month in a row to 1.2% y/y in May from 1.0% y/y in April. It should continue slightly higher but there is upside risk to our forecast, as we expect grain prices to edge higher in coming years, reflecting the firmer outlook for El Niño weather.
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