Inflation outlook
Euro inflation is below the ECB’s 2% target and was 0.8% in December while core inflation reached a new historical low of 0.7% (see Flash Comment). In January, weexpect inflation to be unchanged and inflation is only set to increase slightly in 2015.
Core inflation has declined and is set to remain low in 2014, starting to increase slowly in 2015. This reflects weak price pressure from the labour market due to high unemployment and low labour costs. In 2015, when we expect economic growth to pick up, the unemployment rate should decline and we expect moderate wage growth.
Inflation in food prices increased a bit in December, but due to the decline in global food prices, we expect it to come down further. Looking ahead, even though demand for grains is on track for a decent pick-up this year, it is likely to be outpaced by an expected increase in supply (see Commodities 2014, 16 January 2014).
Energy price inflation also increased in December to 0.0%, having been negative for four consecutive months. We project it to remain around zero. This follows as oil supply is boosted by new technology to make the most of shale formations, while growth in demand is slowing as growth in China is less energy intensive.
The lower inflation is not contradicting stronger growth in the euro area, in our view. Lower commodity prices have increased purchasing power and the most recent decline incore inflation is due to methodological changes and not a result of a drop in wage growth.Real wage growth has shown a clear improvement from its previous decline.
Deflation index
As it appears in Danske Bank’s Euro Area Deflation Index below, there are some differences between countries, but all are placed at or below zero in the deflation index. Germany has moved down in the index mainly due to the methodological changes.
The score of the core countries is held up by PMIs and GDP growth not too far below potential growth. We expect inflation to increase slowly as the recovery puts upward pressure on wages, but lower commodity prices would counter some of it.
The periphery countries are at the low end of the index and inflation should remain very low as high unemployment limits wage pressure. This is partly due to an adaptation of competitiveness, which is necessary to restore sustainable economic growth.
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