Euro area inflation set to remain well below 2% until at least end-2016

Despite the recent increase in headline and core inflation, it is premature to dispel deflation fears, and our vulnerability indicator suggests that euro area-wide deflation risks remain substantial. After having dropped into negative territory at the beginning of 2015 as a result of the fall in oil prices bottoming at -0.6% y/y in January, headline inflation bounced back and reached +0.3% y/y in May, mainly driven by volatile components, and core inflation edged up to 0.9%, mostly on calendar and temporary effects on the services component.

"In June, headline inflation was down to 0.2% as both energy and food inflation came in on the weak side, while core inflation, down to 0.8% y/y, was more of a mixed bag, with services inflation revised slightly up but still close to a historical low of 1.1% y/y, and non-energy industrial goods inflation up to 0.3% y/y from 0.2%", says Barclays.

In the coming months, headline inflation is likely to be driven mostly by base effects related to last year's collapse in oil prices, and core inflation is likely to remain steady around current levels. It is expected,  only a very small and gradual increase in core inflation from spring 2016 as a result of a slowly receding output gap and the pass-through from a weaker euro, but it should remain around 1.1-1.2% until year-end, well below the ECB's 2% target. Taking into account the recent decline in oil futures prices for this year and next (USD55.5/bl and USD63.8/bl) and factoring in preliminary signs that unprocessed food price momentum may have lost some steam, it is expected headline inflation to average 0.2% this year and 1.2% next, 0.1pp below our previously published profile. Risks surrounding our inflation profile are broadly balanced. The FX pass-through transmission mechanism may spread across the NEIG component.

Contrary to this, the contribution to headline inflation stemming from volatile prices may soften further in the short term. Finally, the services inflation outlook remains critical but highly uncertain. It is believed that, secular disinflation will continue in the coming months before turning toward the end of this year. The decline in oil prices over the second half of 2014 had another important effect on the euro area economy, it boosted the current account surplus, which rose to 3% of GDP in Q1 15, its highest level since the creation of the single currency and despite some export softness due to weak global trade. The surplus is likely to increase further in the coming quarters as exports recover, driven by better global demand and some gains in market shares in the wake of the depreciation of the euro. Overall, it is expected the current account surplus to reach 3.2% of GDP both in 2015 and 2016, notes Barclays.