Disappointing eurozone inflation highlights downside risks

We continue to think the ECB will prolong quantitative easing.

31 May 2017

Azad Zangana

Azad Zangana

Senior European Economist and Strategist

After a sharp rise in eurozone inflation at the start of the year, the flash estimate for the Harmonised Index of Consumer Prices (HICP) for May has shown a larger-than-expected fall in annual inflation. Eurozone annual inflation fell from 1.9% in April to 1.4% in May, and compares to consensus estimates of 1.5%.

While the April figures were artificially high due to the timing of Easter, the lower-than-expected results for May suggest that inflation is likely to fall faster than most expect.

Within the details of the latest data, core inflation (excluding energy, food, alcohol and tobacco) fell from 1.2% to 0.9%, also disappointing consensus expectations. Meanwhile, energy inflation fell from 7.6% to 4.6%, as it continues to fall from its peak in February. Lastly, food, alcohol and tobacco inflation remain unchanged at 1.5%.

Softer inflation can benefit consumers

Higher inflation in the first quarter is likely to have caused households to cut back spending as wage growth remains subdued. Eurozone retail sales fell from 0.8% in the fourth quarter (quarter-on-quarter) to just 0.3%. Therefore, inflation falling back is likely to help households by boosting their purchasing power.

However, while lower inflation is generally welcomed, when inflation is too low, concerns over deflation1 start to surface. This has been a big risk in the monetary union over the past two years, and is the reason for the aggressive monetary policy easing being conducted by the European Central Bank (ECB).

Monetary policy to remain accomodative

Looking ahead, we forecast inflation to fall back to around 1% by the start of 2018 as the impact from recent higher energy prices fully fades. This is likely to be too low for the ECB, and so we expect quantitative easing to continue over most of next year, albeit with a lower amount of monthly purchases. Unemployment remains too high in the eurozone to worry about an inflation overshoot, and the latest inflation disappointment highlights the downside risks that still prevail.

1. Deflation is a sustained fall in the prices of goods and services. It is the opposite of inflation.

Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, 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.  To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.