European Inflation: An Inflection Point?

This year’s late Easter may have contributed to an outsized gain in April’s CPI. However, there are signs that underlying inflation in the euro area is turning the corner.


The timing of Easter distorted the March and April inflation data. The March CPI was unduly weak due to this year’s late Easter. The stronger April CPI is partly a payback from last month’s weakness. With headline CPI rising 1.9% y/y, inflation is effectively at the ECB’s “close to but below 2%” target.

The ebbs and flows in headline inflation will be dictated by oil prices. According to the futures market, the annual rate of change in oil prices will moderate, which will lead to slower headline inflation in the latter half this year.

Looking beyond the monthly seasonal noise in the data and the swings in energy prices, there are signs that core inflation is bottoming as the broad disinflationary pressures in the economy are abating. Our CPI diffusion index, which measures the breadth of price movements and leads core inflation, has recovered from the depths of 2013/14. It currently stands at 64%, meaning that the majority of the CPI subcomponents are accelerating. If the eurozone economy continues to grow at an above-trend pace (as our models predict), the output gap will close further and underlying inflation will gradually drift higher.

Bottom Line: The ECB will need to keep dialing back the dovishness as the euro area economy grows above potential and underlying inflation starts to trend higher.

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