EU inflation

headline and core inflation trends

how fast are EU prices rising?

Inflation update:

• headline inflation Y-o-Y growth stands at 1.9%, moving up by 0.20% since last month and around the central bank target of 2%
• core inflation Y-o-Y growth is at 2.4%, moving up by 0.20% since last month , much faster than usual

Insights:

• Inflation is around target at the moment, but rising
• Core inflation is also rising in parallel, meaning that non-volatile components are adding to the pressure.

IntroInflation measures the change in price for goods and services acquired by households over time. Investors commonly talk about inflation to refer to a sustained rise in overall price levels.

MeasureIn Europe we look at the Harmonised Index of Consumer Prices - all items (HICP), which gives comparable measures of inflation for the different countries investigated.

What causes inflationInflation can emerge because of different forces building-up on the demand or supply side.

Demand-pull inflation occurs when the overall demand for goods and services increases faster than production capacity. Such inflation tends to be benign for investors, as it comes with economic growth.
Cost-push inflation instead derives from a supply side shock, pushing up either input prices - such as commodities and/or wages - or distribution prices - such as global supply chain bottlenecks.

Historically, inflation was also believed to emerge also from an increase in money supply (= it is the liquidity offered to banks and markets) by the central bank. But in the last decade this phenomenon did not happen: the QE-induced increase in money supply did not generate inflation.

Chart detailsWe show in the left chart both inflation and core inflation. What is the difference? While inflation normally refers to the price change in all categories of goods and services ("all items"), core inflation - a key measure observed by central banks to understand the impact of inflation on household savings - refers to all items less energy, food, alcohol and tobacco, which are the most volatile components.

Economic consequencesAt macro level, inflation affects consumption and thus economic growth. It is a priority for central banks to set an inflation target: the mission is to both avoid deflation (a decline in price levels) that would postpone consumption, or excessive inflation that would erode purchasing power. The European Central bank (ECB) aims to maintain price stability with an HICP inflation around 2 % over the medium-term (shown with a green dotted line in the charts) to sustain economic growth and employment.

Market implicationsInvestors can deal with inflation in a few ways. Higher inflation is:
· usually good for stocks (especially sectors such as energy, banks, utilities) up to a historical limit of 5/6% price growth YoY (above that, inflation will kill the stock market, as consumption will fade in normally functioning economies)
· usually bad for bonds, as yields tend to rise (prices fall) on the expectation of rate hikes by central banks; it is normally suggested to reduce bond duration or switch to FRNs at times of higher inflation
· usually good for commodities, or real assets

Viceversa, bonds like lower inflation, while the effects are mixed on stocks and commodities (with their prices mainly depending on other factors)

ECB inflation expectations

official ECB forecast

where will EU inflation go next?

ECB inflation projections:

• inflation is likely to be at 1.87% in 1-year from now
• Expectations have gone up (by 0.1%) since the previous quarter
• Current Inflation should decrease by 0.0% in the next year to match the ECB expectations

ECB policy changes expected, given the official forecast:

• as the ECB expects inflation to float around target, interest rates are likely to settle and stay put in the future according to this official reading

IntroThe ECB runs a periodical survey with professional forecasters to project where the inflation is likely to land, one year from now.

Economic implicationsThis chart can help us understand how does the ECB "feel" about upcoming inflation pressures that may dictate any potential monetary action (hiking/cutting interest rates) to affect inflation in the future.

Market implicationsPlease refer to the guide provided on the left under EU inflation.