Eurozone inflation falls further than expected
Bigger than expected drop marks the peak in eurozone inflation and should calm ECB hawks.
The flash estimate for eurozone inflation showed a fall in the annual rate from 2% to 1.5% in March – a much larger drop than consensus expectations (1.8%). The sharp fall should mark the end in the recent surge in inflationary pressure, as we forecast inflation will fall further towards 1% by the end of this year.
Headline inflation, based on the harmonised index of consumer prices (HICP), had been rising in recent months. The drag from energy prices over most of 2015 and 2016 finally fell out of the annual comparison, creating base-effects that raised the annual rate. Indeed, when focusing on the core rate of inflation (excluding energy, food, alcohol and tobacco), annual inflation remains low at just 0.7% - down from 0.9% from a month ago.
The recent rise in eurozone inflation was always seen as a temporary pick-up, but with the annual rate rising above the European Central Bank’s (ECB) target of close to but below 2%, the tone of the governing council started to shift in a more hawkish direction. Indeed, at least one member suggested that interest rates could rise soon, and even before the ECB’s quantitative easing programme was ended. This caused short-term money market interest rates to rise and for the euro to strengthen. However, with inflation now likely to head lower, ECB hawks are likely to retreat for the time being. At the time of writing, government bond yields in the eurozone and the euro have fallen slightly in reaction to the latest data.