Eurozone deflation of 0.2% confirmed in April, core inflation at just 0.7%

Final Eurostat data confirm the "flash" estimate showing that the Eurozone fell back into deflation in April as consumer prices fell by 0.2% year on year (y/y), having been flat y/y in March. Consumer prices had previously fallen by 0.2% y/y in February, which had been quite a relapse after Eurozone consumer prices had risen by 0.3% y/y in January. The Eurozone's exit from deflation in March followed by a return in April was clearly influenced significantly by the earlier Easter in 2016 compared with 2015. This meant that most of the Easter-related price spikes (notably for holidays and air transport) occurred in March in 2016 compared with April in 2015, which affected the y/y changes in consumer prices. This was particularly true of Germany.

In fact, the Eurozone has been drifting in and out of deflation since it first occurred in December 2014. There were four months of deflation through to March 2015, peaking at 0.6% in January 2015, and it also occurred in September 2015, when consumer prices fell by 0.1% y/y. In between, the Eurozone has experienced limited inflation, which peaked at 0.3% in both January 2016 and May 2015. This compares with the European Central Bank (ECB) target for Eurozone consumer price inflation of "close to, but just below 2.0%". Eurozone consumer price inflation first moved below what the ECB considers to be a danger level of 1.0% in October 2013, and it has remained below this level ever since. Although this had been largely due to extremely low oil and commodity prices, core inflation has also been well below what the ECB would like to see.

Energy prices still down markedly y/y in April

The Eurozone was in deflation in April primarily because energy prices fell 8.7% y/y. However, this did at least mark a stabilisation of the rate of decline after it had widened to 8.7% in March from 8.1% in February and 5.4% in January. This was the legacy of oil prices hitting a near 12-year low in January. Although oil prices have since come well off their January 2016 lows, there had also been a firming of oil prices in the early months of 2015.

Meanwhile, the y/y increase in unprocessed food prices edged back to 1.2% in April after rising to 1.3% in March from just 0.6% in February.

Core inflation down to 12-month low

Core Eurozone inflation (which excludes energy, food, alcohol, and tobacco) fell back to 0.7% in April after rising to 1.0% in March from 0.8% in February. This was actually a 12-month low as core inflation had previously been locked in a range of 0.8–1.1% since May 2015.

April's drop in core inflation was clearly substantially influenced by an unwinding of March's Easter-related spike in holiday and travel prices. Indeed, services inflation retreated to 0.9% in April after rising to 1.4% in March from 0.9% in February. In contrast, the y/y increase in non-energy goods remained at 0.5% in April, after dipping to this level in March from 0.7% in both February and January.

Twelve Eurozone countries experience deflation in April

The number of Eurozone countries experiencing deflation rose to 12 in April after dipping to 10 in March from 11 in February. This is up from six in January. It had peaked at 17 in January 2015. Germany moved back into deflation in April as consumer prices fell 0.3% y/y after a gain of 0.1% y/y in March. The Netherlands also moved into deflation as there was a marked turnaround in consumer prices there: they fell 0.2% y/y in April following a rise of 0.5% y/y in March.

The other countries experiencing deflation in April were Cyprus (2.1%), Spain (1.2%), Slovenia (0.7%), Latvia (0.7%), Luxembourg (0.6%), Italy (0.4%), Greece (0.4%), Slovakia (0.4%), Ireland (0.2%), and France (0.1%). Additionally, consumer prices were flat y/y in Estonia during April. There was consumer price inflation during April in Finland (0.3%), Portugal (0.5%), Austria (0.6%), Lithuania (0.8%), Malta (1.0%), and Belgium (1.5%).

Outlook and implications

The chances that this latest bout of Eurozone deflation proves brief have been boosted by the recent rise in oil prices and an overall firming of commodity prices. Specifically, Brent oil is currently trading around USD49/barrel (compared with January's 12-year low of USD27.1/barrel). Additionally, commodity prices have recently been firmer overall. IHS believes there should be a gradually increasing upward impact on inflation over the coming months from reduced y/y drops in energy prices helped by base effects and firmer oil prices. Specifically, we expect Brent oil prices to hover in a range of USD45–USD50/barrel for an extended period to average USD44.0/barrel in 2016 and USD52.1/barrel in 2017. Additionally, we believe that commodity prices will slowly pick up. Furthermore, Eurozone GDP growth is seen at 1.7% in 2016 and 1.8% in 2017, which should gradually support some increase in prices. This assumes that following the pick-up in GDP growth to 0.5% quarter on quarter (q/q) in the first quarter of 2016 from 0.3% q/q in the fourth and third quarters of 2015, Eurozone GDP growth holds in a range of 0.4–0.5% q/q.

Nevertheless, it will clearly be a long, hard task to get Eurozone consumer price inflation back up to the ECB's target rate of "close to, but just below 2%". Underlying inflationary pressures are likely to pick up only gradually from their current low levels, reflecting still large output gaps in many countries, intense competitive environments, high unemployment, and price-aware consumers. Output gaps are wide in most countries following prolonged economic weakness and so will take some time to close, especially as Eurozone growth is currently struggling for momentum. Meanwhile, Eurozone consumers remain generally very conscious of price, so this combination will maintain pressure on retailers, manufacturers, and service providers to price competitively. Indeed, the latest European Commission survey showed that pricing expectations were still well below long-term averages in April among manufacturers and retailers, although they were slightly higher for services companies; developments were firmer over March itself. The European Commission's survey also showed that consumers' inflation expectations were substantially below long-term norms in April, although they did at least edge up from a five-month low in March (the index rose to +2.9 in April after falling to +2.1 in March from +3.7 in February; this is sharply below the 1990–2016 average of +19.3). Also significantly, although the Eurozone unemployment rate has fallen from a peak of 12.1% in the second quarter of 2013 to stand at 10.3% in February 2016, it is still elevated, which continues to limit workers' bargaining power on wages. Meanwhile, companies are keen to hold down pay to limit their costs in a highly competitive environment. Reflecting these factors, annual growth in total labour costs was limited to 1.3% across the Eurozone in the fourth quarter of 2015.

Consequently, Eurozone consumer price inflation is expected to trend upwards gradually to 0.9% at the end of 2016 and 1.7% at the end of 2017. This means that Eurozone consumer price inflation is not expected to return to its target of "close to, but just below 2.0%" before 2018.

ECB likely to remain in "wait and see" mode for prolonged period

The Eurozone's relapse into deflation in April is unlikely to deter the ECB from staying in "wait and see" mode for the time being – especially as Eurozone GDP growth came in at a better-than-expected 0.5% q/q in the first quarter of 2016. Although it will hardly be pleased to see the Eurozone dipping back into deflation in April, the ECB will not be surprised as it had observed at its April policy meeting that further near-term falls in consumer prices were possible.

ECB policymakers have recently been out in some force stressing that patience is needed in getting Eurozone inflation up as it will take time for the comprehensive package of further stimulus measures it announced in March to be fully enacted. Indeed, some of the measures have not even started to kick in yet – such as the targeted long-term refinancing operations. Additionally, the ECB has not yet started to buy corporate bonds as part of its quantitative easing programme (this will start in June). Furthermore, although the ECB has indicated that it is prepared to eventually take further stimulative action if deemed necessary, it has also made it clear that it believes other policy action across the Eurozone is important to try to boost growth, with structural reforms to lift productivity essential. IHS increasingly leans towards the view that the ECB will not take further stimulative action.