Euro Area Inflation Declined To 0.7% In October

Inflation outlook
Euro area inflation is below the ECB’s 2% target and declined to 0.7% in October. The decline is due to a combination of low wage pressure and the end of the super-cycle in commodity prices. We expect inflation to remain far below the ECB’s target in 2014-15.

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. During 2012, food inflation moved sideways around 3%, while headline inflation declined. Looking ahead, we believe inflation in food prices will be lower and headline inflation will decline further.

Energy inflation has moved downwards and we project it will remain negative 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 increase 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 place at or below zero in the deflation index. This follows as the low level of inflation is broad based and we do not expect it to increase instantly.

Even the core countries place at or below zero in our deflation index but the numbers are held up by higher 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 upward pressure on prices.

The periphery countries are at the very low end of our deflation index and we expect inflation to remain very low as high unemployment rates limit wage pressure. The low inflation rates should be seen as part of an adaptation of competitiveness, which is necessary to restore sustainable economic growth in the periphery.

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