Euroland: Headline Inflation Peaking as Growth Weakens
Euroland: Headline Inflation Peaking as Growth Weakens
Final Euroland HICP for July implied a downward revision to 4.0% y/y of the flash estimate of a 4.1% increase in consumer prices on a yearly basis. We expect headline inflation will remain elevated for a couple of months but gradually decline from October onwards.
Today’s HICP figures did not entail any big surprises. Core inflation (i.e. total ex energy food alcohol and tobacco) was 1.7%, down 0.1 percentage point relative to June. Using the ECB definition of core inflation (total ex energy and unprocessed food prices) prices grew by 2.5% y/y, which is unchanged relative to June. Thus apart from the relatively volatile parts of HICP - which are beyond the reach of the ECB - inflation rates have stayed relatively stable so far.
We expect core inflation to remain moderate until late summer but then increase rather sharply in autumn as past increases in goods prices make their mark on service prices. The effect on headline inflation is, however, more than offset by the assumed declining contribution from food and energy prices - given the recent price declines on these items - and base effects beginning to materialise (around October). This will of course crucially depend on oil price developments. We forecast that oil prices will stay at current levels for the rest of 2008 and edge higher in 2009.
The long-term inflation expectations of professional forecasters released today edged up to 2% from 1.9%. The ECB monitors this survey closely, and a rate of 2% calls ECB credibility into question, as it indicates that forecasters doubt that the ECB is able to fulfil its mandate of price stability (HICP inflation below but close to 2% in the medium term). However, we do not think one should put too much emphasis on the rise in inflation expectations given the weak growth figures coming out of the Euro area that point towards further underlying weakness in the economy. Detailed data for the Euro area have not been released, but the individual country data indicate that growth in all major Euroland economies is weak.
In Germany, GDP declined by 0.5%. Thus rumours of a 1% drop were false. According to comments made by the German statistical bureau, construction investments were considerably weaker than in Q1. This is most likely due, in part, to a correction after the strong Q1 figures, which were boosted by the unusually warm winter. The bureau also mentioned that net exports contributed positively to GDP growth in Q2 due to a big decline in imports. This indicates that domestic demand is weak - most likely due to some destocking following the strong stock-build in Q1. Overall, the figures show that the German economy is slowing. In our view, underlying growth in Q2 has been approximately 0-¼% q/q, down from approximately ½-¾% in Q1. Thus today’s GDP figures do not change our view on the German economy expressed in our research paper Germany: Recession looming. We expect growth to weaken even further in H2, and as a result Germany may slide into recession.
French GDP declined by 0.3% as household consumption grew by just 0.1%, suffering from high inflation and tighter lending conditions. Investments declined by 1.5%. Both business and household investments declined, as the housing market has collapsed and exports are giving in. Exports fell by 2.0% in the face of weak export-market demand and a strong euro. The decline in exports was not counterbalanced by a drop in imports despite the soft domestic demand. Inventories contributed 0.3 percentage points to growth. We do not foresee any significant change in this situation in the coming months. Most of the negative factors affecting the economy will remain in place for the rest of 2008, although inflation may ease somewhat, providing some room for an increase in consumption. France may enter a recession.
Spanish GDP was 0.1% q/q in Q2. This is the lowest growth rate reported in 15 years.
Market reaction was limited, reflecting that the inflation figures did not come as a big surprise. In our view, today’s inflation and growth figures support our forecast that the ECB will leaving rates unchanged in the coming months. The ECB is sidelined for now, as inflation remains a concern. We also continue to recommend buying on dips in the bond market, as we think bond yields will be pushed lower on the back of more weak data in the coming months.
Danske Bank
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