By: Alessandra Yuan – Forex Focus
Key highlights of the consumer inflation numbers for July 2018 and their effect on monetary policy
Eurozone annual consumer inflation edged up to 2.1 percent in July 2018, continuing its upward streak after recording a 2-percent growth in June. The annual inflation figures, the highest since December 2012, were led by a rise in the prices of energy and services, and they also exceeded the European Central Bank’s (ECB’s) target of keeping inflation within the 2-percent band for the first time since early 2013. Month-on-month, consumer prices slipped 0.3 percent after gaining 0.1 percent in June, in line with market consensus.
Breakdown of the inflation numbers
The climb in the inflation rate is said to be attributable to high energy prices on the back of a strong showing in the global prices of crude oil and acceleration in the prices of the services sector and non-industrial output. The corresponding figures for energy, services and non-energy industrial goods were recorded at 9.5 percent, 1.4 percent and 0.5 percent against 8 percent, 1.3 percent and 0.4 percent in June. Meanwhile, prices of food items softened to 2.6 percent from the previous month’s reading of 2.9 percent.
Annual core inflation (which excludes the volatile prices of energy, food, alcohol and tobacco), a key parameter used by the European Central Bank for framing policy decisions, also registered a growth of 1.1 percent in July against the previous month’s 0.9 percent.
Looking at the geographical segregation, the rise in inflation can be largely witnessed in the eurozone’s principal economies—namely France, Spain, Germany and Italy, which recorded inflation figures of 2.6 percent, 2.3 percent, 2.1 percent and 1.9 percentrespectively.
What the numbers mean for the eurozone economy.
The rise in inflation comes at a time when the eurozone economy witnessed a sharp downturn in the first two quarters of the current year after having logged in robust growth numbers throughout 2017.
Eurostat, the European Union’s (EU’s) statistical office, earlier announced that the eurozone economy expanded at 0.4 percent quarter-on-quarter in the second quarter of 2018, unchanged from the previous quarter and the lowest since the July-September quarter of 2016. The quarter-on-quarter economic expansion in the first two quarters has also halved from the 0.7-percent quarter-on-quarter growth reported during the previous five quarters. Likewise, annual economic growth in the eurozone also plunged after peaking at 2.8 percent in the last two quarters of 2017. In the first quarter of 2018, the economy expanded at an annual rate of 2.5 percent before slipping further to 2.2 in second-quarter 2018.
This economic momentum seems to be wearing off in 2018, with experts doubting their previous forecasts about a robust economic recovery in the euro area. However, the good news is that industrial production continues to remain strong, and the Purchasing Managers’ Index (a gauge of business activity) remains well above the 50-mark. The unemployment rate, too, continues to hover near 10-year lows of 8.5 percent. So the current inflation numbers can be seen as a streak of good news.
However, it is imperative to ask whether the positive macro indicators signal a continued recovery in the economy, or if the inflation numbers are of consequential significance only in terms of the expectations of the European Central Bank’s criteria to put a stop to the bond-buying program, which the bank has indicated will be carried out eventually.
ECB President Mario Draghi has time and again indicated that the central bank will start phasing out its asset-purchase program subject to the medium-term inflation outlook. The present buying of £30 billion worth of assets each month will be tapered to £15 billion a month starting from September 2018 and phased out completely towards the end of December 2018. The optimistic macro-indicators are suggestive of the fact that the European Central Bank will push ahead with its stimulus exit after the economy’s decade-long struggle with financial crisis and recession.
Indications for the future
The growth in the eurozone is projected to extend its upward momentum, with expectations for 2.0 to 2.6 percent growth in 2018 and 1.5 to 2.3 percent expansion in 2019. This will be fueled by domestic fundamentals such as improved labor-market conditions, lower household debt and higher consumer confidence. The business climate will be lucrative, with favorable financing conditions, steady income and profit growth, which are expected to support private consumption and investment. This forecast remains susceptible to risks arising from uncertainty in the external environment, with slow global recovery and trade tensions with the United States, the largest trading partner for countries in the eurozone. Also, a strong euro will pose a downward risk to export growth. These growth numbers will also be clouded by political developments in the region. Although the political situation in Germany seems to be under control, with the Social Democrats’ decision to remain in coalition with Angela Merkel’s bloc, tensions in other parts of the eurozone such as Italy and Spain pose significant risks to forecasted growth. Additionally, the economies within the region have to grapple with unfavorable demographics and focus on boosting productivity and investment for a sustained growth path in the longer-term.