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Lower Euro Area Inflation As Tax Hikes Drop Out‏

ByDanske Markets
Published 06/19/2013, 08:46 AM
Updated 05/14/2017, 06:45 AM
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Inflation in the euro area has been on a downward trajectory since September 2012. If inflation moves even lower and the risk of deflation increases, it could add pressure on the ECB to cut interest rates further.

The recent decline in inflation is caused partly by the fall out of last year's tax hikes. After a period of fiscal tightening where substantial tax hikes in a number of countries pushed headline inflation up, this temporary effect is now vanishing.

The impact of tax hikes on inflation peaked in September 2012 when it explained as much as 0.6pp of inflation. Since then, the impact of tax hikes has fallen, to 0.4pp in May 2013, when inflation without taxes was just 1.0% compared with 1.4% including taxes.

We expect euro area inflation to be driven down even further as the impact of tax increases continues to drop out. The Spanish government has planned additional tax increases this year and as a result, taxes will drop out of inflation only gradually.

All in all, we estimate the drop out of taxes will cause a 0.2pp decline in euro area inflation over the remainder of this year and almost 0.2pp more next year.

We expect euro area inflation to bottom at 1.0% in September this year. In 2014, we expect the negative impact of the drop out of taxes to be countered by a positive impact from higher wage pressure (primarily in Germany).

The drop out of taxes from inflation does not in itself entail deflationary risks, and should therefore not trigger a rate cut from the ECB.

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