Eurozone’s annual inflation to accelerate by 1pp in coming six months, core inflation path still uncertain

Euro area’s annual headline inflation is expected to accelerate by about 1 full percentage point in the six months ahead. According to a Soctiabank research note, inflation is expected to rise to 1.4 percent in February 2017 from 0.4 percent in September 2016. The acceleration is expected to be mostly driven by favorable base effects from food prices and energy prices.

“Beyond February of next year, we expect that consumer prices will remain range bound, coming in at an average annual rate of around 1.2 percent y/y in 2017 and 1.4 percent y/y in 2018”, added Scotiabank.

However, this scenario suggests acceleration in core inflation which, until this point, has not been able to show any improvement and has stayed at about 0.8 percent year-on-year. The soft path in core inflation probably shows the lagged indirect effect of past lower oil prices on services, especially non-durable goods and transportation prices.

As oil prices are improving, these factors are expected to begin reversing and add to gradually pushing up core inflation. Moreover, closing of the output gap in the midst of ongoing improvements in the labor market is expected to provide additional support, according to Scotiabank.

But renewed concerns about the banking sector’s health and the monetary policy transmission’s efficiency in the medium term might create risks on the downside to this scenario.

“We also cannot exclude the risk that ongoing weakness in bank share prices reduces the traditional elasticity between core inflation and both GDP growth and oil prices”, notes Scotiabank.