Euro area inflation increased to 1.9% y/y in April from 1.5% y/y in March, while core inflation jumped to 1.2% y/y from 0.7% y/y, thereby reaching the highest level in four years. The higher core inflation reflected higher service price inflation.
The question remains whether the higher service price inflation reflects a rise in underlying price pressure, which would change the ECB's monetary policy stance. Based on our calculations, a very large part of the rise in service price inflation is due to the early Easter last year, which is also reflected in the details about the German CPI inflation.
Among the remaining components of service price inflation we see few signs that the underlying price pressure has started to pick up. The largest component of service price inflation is recreation and personal care excluding package holidays. This figure was still hovering around a historically low level in March, likely reflecting the lack of underlying price pressure.
The higher service price inflation is clearly good news for the ECB, but given that much of the rise seems to be due to the early Easter last year and is not reflecting a rise in underlying price pressure, we stick to our view that the ECB will continue its QE purchases into 2018.
However, after having looked into the inflation details and revised our core inflation forecast slightly upwards, we now expect the ECB to reduce its purchases to EUR40bn per month starting from January 2018 and continuing for at least six months. In our view, it is still premature to discuss rate hikes from the ECB.
Ahead of the next ECB meeting in June, the inflation figure for May will be released, which will be crucial for whether the ECB will change its communication in a more hawkish direction and whether it will change its forward guidance. We expect a decline in core inflation to 1.0% in May but this is higher than seen recently and should support a more hawkish communication from the ECB at the meeting in June.
To read the entire report Please click on the pdf File Below