Euro area inflation increased to 1.8% y/y in January, which is the highest rate since February 2013 and above consensus at 1.5% y/y. The rise in inflation was driven mainly by energy and food price inflation, which together had a contribution of 1.1pp up from 0.5pp in December.
Core inflation was unchanged at 0.9% y/y in January and has therefore not been above 1.0% since October 2015. The unchanged core inflation reflected a 0.1pp decline in service price inflation, whereas non-energy industrial goods price inflation was up by 0.2pp.
Higher inflation was seen across countries - Spanish inflation was 3.0% and significantly above the ECB's 2% target - hence, the ECB can conclude that it is not only German inflation that is higher. That said, it still remains to be seen whether the rise in inflation will affect the medium-term horizon and whether it is a durable, self-sustained convergence.
We expect core inflation to stay low at 0.9% on average this year, primarily as labour market slack in the periphery countries should keep wage growth subdued. Core inflation will, in our view, be supported by an indirect impact of the higher oil price but this should not be enough to bring core inflation persistently above 1.0%, as there is less tailwind from a euro depreciation (see more about the main drivers of core inflation below).
The bottom line is that we do not expect the higher inflation figures to change the ECB's monetary policy stance, as the underlying price pressure is still weak. Although some ECB members have started to express a more hawkish stance recently, consensus in the ECB seems to be that core inflation also needs to rise before the ECB will discuss tapering. We still believe the ECB will announce a third QE extension this year.
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