Stable Inflation In July

Inflation was stable at 1.6% in July according to Eurostat’s flash estimates released this morning. Inflation is expected to resume trending downwards over the coming months, averaging 1.4% this year and 1.2% next year, that is well below the ECB inflation target for price stability in the medium term.

Inflation was stable at 1.6% in July, according to Eurostat’s flash estimates released this morning. Details showed that food price inflation increased in July while energy price inflation was stable and core inflation (ex food and energy) eased to 1.1% from 1.2% in June.

■ Inflation was stable in Germany while it declined in southern countries. Lower levels of activity, higher unemployment rates and ongoing adjustment processes are among the elements behind these differences among countries. The price adjustment mechanism within the zone begins to be more visible, while over the past months VAT increases in southern countries have masked the process. Unit labour costs are falling in several peripheral countries (-3.2%y/y in Q1 in Spain), while they are increasing in Germany (+3.3% y/y in Q1).

■ Going forward, we expect eurozone inflation to ease as several factors will continue to exert downward pressures on inflation. First of all, price and cost pressures are very limited on the domestic front, if not absent. The weakness of demand is forcing firms to offer price discounts. Wages, the main driving factor behind domestic inflation, are unlikely to pick up any time soon. The unemployment rate was stable at 12.1% in June, but still, the highest rate since the launch of the euro and it is likely to break new records over the coming months. Core inflation, highly sensitive to domestic price pressures, should therefore constantly moderate, although slowly, over the forecast horizon. As energy and food price inflation are expected to moderate as well, reflecting lower commodity prices, we expect headline inflation to average just 1.4% in 2013 and 1.2% next year.

■ What we can expect from tomorrow’s ECB Governing Council meeting? July’s survey data have been rather encouraging, with the Composite PMI for activity, coming back into expansionary territory for the first time since January 2012. Confidence indicators, therefore, seem to support the ECB’s view of output swinging back to growth in H2. Yet, we do not expect the ECB to depart from its accommodative monetary policy stance. The recovery is not yet on solid feet. In addition, price and cost pressures are absent and inflation this and next year, will be well below the ECB inflation target for price stability. This means that an accommodating monetary policy is warranted.

BY Clemente DE LUCIA

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