The euro area data that were released today were mixed with better-than-expected activity figures but lower inflation.
GDP growth surprised on the upside as it increased 0.6% q/q up from 0.3% in Q4 15 and above expectation of an increase of 0.4% q/q. The details behind the higher GDP growth have not been released yet but based on other incoming data the stronger growth is driven by higher private consumption, which is supported by the still low oil price and progress in the labour market. In France, fixed investments were also strong despite the global financial turmoil in the beginning of the year. Net exports should have been less supportive given the weakness in the US and Chinese data at the start of 2016.
The euro area unemployment rate was lower than consensus expected as it declined to 10.2% in March from 10.4% in February. This is the lowest level since mid-2011 so before the euro crisis kicked-in. The level is not far from the structural unemployment rate, which the European Commission estimates to be 9.8%, but this estimate is likely to be revised lower as it is approached. Our view is that it will take some time before the euro area wage pressure picks up.
Finally, both headline and core inflation were lower than consensus expectations. Headline inflation is back in deflation territory at -0.2% from 0.0% in March, while core inflation was 0.8% after the temporary increase to 1.0% in March. The higher core inflation in March followed due to the early timing of Easter. Generally, we expect core inflation to remain around the current level as it is held down by subdued wage pressure, headwind from the stronger effective euro and a lagged impact from the past decline in the oil price.
The better activity data support the ECB's current patient stance but the low inflation is a concern. Particularly the low core inflation should not be welcomed at the ECB as it expects core inflation to increase to an average of 1.1% in 2015. The ECB's argument for higher core inflation is that a closing output gap will translate into higher wages and hence lift core inflation, but in our view this is too optimistic given the slack in the labour market.
We expect the ECB will remain side-lined in the global currency war and not cut policy rates further. From a longer-term perspective, we believe the ECB will extend the QE purchases beyond March 2017. This should occur as inflation in our view will not pick up sufficiently for the ECB to remain on hold.
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