Schroders Quickview: Energy price drop turns eurozone inflation negative
The preliminary estimate for eurozone HICP inflation shows annual price inflation has fallen into negative territory for the first time since October 2009.
7 January 2015
Inflation fell from 0.3% year-on-year (y/y) to -0.2% y/y in December, disappointing consensus expectations of -0.1% and raising fears that the eurozone is headed for a prolonged period of deflation. However, the details available so far show that the fall in inflation is being driven largely by external factors. When energy, food, alcohol & tobacco are excluded, the annual core inflation rate actually picked up from 0.7% to 0.8%.
We expect the ECB to change the composition of its asset purchases to include sovereign bonds in March, with a possible pre-announcement following the January meeting.
The main driver of the drop in inflation has been the sharp fall in the energy sub-index. The price of European natural gas was hit at the start of 2014 due to unusually warm weather, while the recent collapse in global oil prices has also had a big downward impact.
Chart: Contribution to eurozone annual Harmonised Index of Consumer Prices (HICP) inflation rate
Source: Thomson Datastream, Eurostat, Schroders. 7 January 2015.
Deflationary fears are likely to remain high, and will probably increase pressure on the European Central Bank (ECB) to add further stimulus. However, there are few signs that the domestic European economy is becoming more deflationary. Consumer confidence remains reasonably high, while inflation expectations have not fallen to significantly low levels. Also, retail sales have held up well, suggesting households are not delaying spending in order to take advantage of falling prices. These are behavioural changes that are associated with the start of a prolonged deflationary period, like that experienced in Japan.
Domestically-driven inflation like the core rate (or even services inflation, which held up at 1.2% y/y) is low, but it does not signal deflation. Nevertheless, low headline inflation in itself increases the risk of deflation, as many administered prices domestically are linked to the headline rate. For example, following the fall in the headline rate into negative territory in 2006, the core inflation rate fell sharply about six months later. We could see this happen again later this summer. For this reason, we expect the ECB to change the composition of its asset purchases to include sovereign bonds in March, with a possible pre-announcement following the January meeting. The ECB may also choose to communicate a more ambitious purchasing target (larger balance sheet expansion), and may even look to accelerate the expansion of its balance sheet.
- Europe ex UK
- Azad Zangana
Important Information: The views and opinions contained herein are those of Schroders’ Investment team, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. UK: Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA, is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped or monitored. Further information about Schroders can be found at www.schroders.com US: Schroder Investment Management North America Inc. is an indirect wholly owned subsidiary of Schroders plc, a SEC registered investment adviser and is registered in Canada in the capacity of Portfolio Manager with the Securities Commission in Alberta, British Columbia, Manitoba, Nova Scotia, Ontario, Quebec and Saskatchewan providing asset management products and services to clients in Canada. 875 Third Avenue, New York, NY, 10022, (212) 641-3800. www.schroders.com/us