Inflation outlook
Euro area inflation is below the ECB’s 2% target and was 0.9% in November. We expect inflation to decline again in December primarily due to methodological changes to German inflation, see German inflation will fall to 0.9% in December, 11 December. Looking ahead we see inflation at 0.7% and 1.0% in 2014 and 2015, respectively. This is below ECB’s projection of inflation.
Core inflation has declined and is set to remain low in 2014, starting to increase slowly in 2015. This reflects weak price pressure from the labour market due to high unemployment and low labour costs. In 2015, when we expect economic growth to pick up, we believe the unemployment rate will decline and we expect moderate wage pressure.
Inflation in food prices has declined recently and we expect it to slow down further because of the decline in global food prices. Additionally there is a downward base effect, which will imply lower food price inflation in the first part of 2014.
Energy inflation has moved downwards and we project it will remain around zero until mid- 2015. This follows as new technology to make the most of shale formations is boosting oil supply, while growth in demand is slowing as growth in China is less energy intensive. The lower inflation will add to growth in the euro area, in our view. The most recent decline in inflation stems more from lower commodity prices, which increases real income and hence purchasing power. Real wage growth has shown a clear improvement from its previous decline.
Deflation index
As it appears in Danske Bank’s Euro Area Deflation Index below, there are some differences between countries. However, all countries except Germany are placed below zero in the deflation index, which follows as the low inflation is broad based. For Germany the ranking above zero should be temporary as inflation is set to fall in December.
The score of the core countries is held up by PMIs and GDP growth not too far below potential growth. We expect inflation rates to increase slowly, as the recovery puts upward pressure on wages but a decline in commodity prices would counter some of the pressure.
The periphery countries are at the low end of our deflation index and inflation should remain very low as high unemployment rates limit wage pressure. This is partly due to an adaptation of competitiveness, which is necessary to restore sustainable economic growth.
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