FDD - Eurozone Inflation: A Downward Slope
2023-03-10 16:14:00 ET
Summary
- Last week saw the eurozone’s headline inflation for February decline to +8.5% YoY although core inflation (excluding food and energy) came in above expectations at +5.6% YoY.
- Food inflation remains the key driver of headline inflation (+15% YoY), in a large part due to fresh food.
- The weight of each item in the inflation basket is updated every year to reflect household consumption patterns the prior year.
By Yanick Loirat, PhD
Lower energy prices and base effects are likely to reduce eurozone inflation, though a return to the 2% target may be slow.
Last week saw the eurozone’s headline inflation for February decline to +8.5% year-over-year (YoY) although core inflation (excluding food and energy) came in above expectations at +5.6% YoY.
Energy’s contribution to inflation was still positive, but its effect has slowed (+13.7% YoY vs. 40% YoY at its height) and should continue to fall (+4% YoY expected in March) due to base effects, one year after the Russian invasion of Ukraine. Food inflation remains the key driver of headline inflation (+15% YoY), in a large part due to fresh food (February weather was cold and dry in many countries). However, high food prices should decelerate due to lower demand from consumers. In France, negotiations between producers and distributors and retailers ended with lower-than-expected prices, and distributors agreed to restart special offers. Services prices have surprised to the upside, likely due to higher wages (+4.8% YoY), while goods inflation continues to trend upward (+6.8% YoY) but should ease soon.
The weight of each item in the inflation basket is updated every year to reflect household consumption patterns the prior year. In normal times, these changes are benign but, due to large swings in consumption last year (due to the reopening of leisure and activities after COVID and the impact of high gas and electricity prices), inflation index weight changes this year have been large. Seasonal effects have also increased versus 2022 with more effects from package holidays. This may lower core inflation in January and increase it during July, particularly in Germany, which represents 28% of the euro inflation index.
By our estimates, new weights may have pulled down January core inflation by 30 basis points (with a final release of 5.3% YoY instead of 5.6% YoY), suggesting that core figures have stagnated. However, we believe that core Inflation should remain above 5% YoY for several months - forcing the European Central Bank to monitor things closely - but that it should peak soon. We do not expect core inflation’s return to the 2% ECB target before 2024.
Looking ahead, wage growth remains the main uncertainty in forecasts, although, even with low unemployment, labor shortages in certain sectors and increasing minimum salaries, strengthening wage growth dynamics do not compensate for realized inflation. All in, we don’t anticipate a wage-price spiral. Due to lower energy prices and especially lower natural gas prices since December, we expect the ECB to lower its headline inflation forecasts at its next meeting.
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Eurozone Inflation: A Downward Slope