Euro area inflation increased to 1.1% y/y in December which is the highest rate since September 2013 . The rise in inflation was mainly driven by energy and food price inflation, which together contributed 0.5pp, up from 0.0pp in November. In the next two months the contribution should continue higher and lift headline inflation to 1.6% y/y in February.
Core inflation was slightly higher at 0.9% y/y in December after having been unchanged at 0.8% y/y for four consecutive months . The higher core inflation was driven by a 0.1pp pick up in service price inflation whereas non-energy industrial goods price inflation was unchanged.
The higher service price inflation probably does not reflect higher underlying price pressure and is thus not a beginning of a sustained adjustment in the inflation outlook . Instead, the rise in service price inflation is likely to reflect primarily a rise in inflation in the volatile package tours prices, as suggested by the German figure released yesterday.
We do not expect the higher inflation figures will change the ECB's monetary policy stance as the underlying price pressure is still weak . In line with recent comments from prominent ECB members, executive board member Benoît Cæuré at the end of December last year said ' we are still waiting for signs that core inflation is on the rise and will clearly exceed 1% '.
We expect core inflation to stay below 1.0% during most of this year, whereas the ECB looks for a rise to 1.1% on average . In our view, the ECB is too optimistic on the wage outlook and we believe slack in the labour market particularly in the periphery countries will keep wage growth subdued during this year. We still believe the ECB will announce a third QE extension this year.
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