Euro area HICP inflation was slightly higher than expected in July as it increased to 0.2% y/y from 0.1% y/y in June (consensus 0.1%) . The rise in inflation was mainly driven by food price inflation which was 1.4% y/y, up from 0.9% y/y in June. The lower oil price in July implied there was a monthly decline in energy prices of 0.9%, but the yearly inflation rate was only down at -6.6% from -6.4% reflecting that the base from last year pulled towards an increase in energy price inflation.
Core inflation was also slightly higher than expected as it remained unchanged at 0.9% y/y (consensus 0.8%) . Service price inflation was slightly higher at 1.2% y/y in July compared with 1.1% y/y in June. The higher service price inflation may be due to the volatile 'package holidays' and hence temporary, but there have also been signs that the stronger recovery has supported service price inflation and due to a lagged impact this could continue going forward.
Looking ahead, we expect headline inflation will increase sharply driven by a slightly higher oil price . Large base effects due to the drop in the oil price last year imply headline inflation is likely to go towards 1.0% at the end of this year if the oil price goes a bit higher than the current level. The market is still pricing short-term inflation much lower than our forecast.
The flash estimate for euro area GDP growth in Q2 was also released today and was 0.3% q/q, in line with consensus . Domestic demand has been the main driver of GDP growth in recent years, but the higher oil price during Q2 is likely to have been a headwind to private consumption.
The unemployment rate in June was unchanged at 10.1%, which was also consistent with consensus expectations . The unemployment rate has declined for three consecutive years and is only 0.4pp from the European Commission's estimate of the structural unemployment rate. When this level is reached, it is likely to give upward pressure on wages. Looking ahead, if economic activity weakens it should also affect the unemployment rate, but due to low potential growth in the euro area modest GDP growth is enough for the unemployment to remain on a downward trend.
The GDP growth and unemployment figures both cover the pre-Brexit period, but looking at the latest economic survey indicators they suggest a somewhat resilient economic sentiment despite the UK's vote to leave the EU . Only investor expectations seem to have been considerably affected as reflected in the substantial decline in ZEW expectations. The limited impact is against our expectation of a hard hit to business sentiment which would result in lower investments. However, it is still early days and the financial uncertainty could still have a spill-over to economic sentiment.
The fairly resilient economic sentiment also reduces the pressure on the ECB to ease again in September . Currently, the ECB sees the risks to the growth outlook as tilted to the downside, but it is waiting for more information to assess the impact of the Brexit vote. We still believe the ECB will announce more easing in September as we foresee a weakening in economic data. Moreover, market based inflation expectations are very low and we do not believe the ECB will be able to conclude inflation is on 'a sustained adjustment consistent with its inflation aim' implying it will extend the QE purchases beyond March 2017.
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