Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
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Euro Area: The inflation shocker
Christopher Dembik
Head of Macro Analysis
Summary: Earlier today, the euro area flash HIPC and core inflation were released for the month of August. It is a big miss. The euro area flash HIPC is in contraction at minus 0.2% vs est 0.2% and 0.4% prior and core inflation is out at 0.4% vs est 0.8% and 1.2% prior. Once again, core inflation fails to pick up. The consensus was clearly a bit off the market due to its inability to price in the reversal in non-energy goods inflation in the past month. Following these disappointing figures, pressure will likely mount for the ECB to increase its PEPP envelope by year-end in order to address investors' concerns about low inflation.
It should come as no surprise that the euro area flash HICP and core inflation are significantly down in August. Most of regional surveys that have been released over the past days confirmed a contraction or a slowdown on a YoY basis. In Germany, HICP contracted at minus 0.1% vs 0.0% prior, in Spain it was out at minus 0.6% vs minus 0.7% prior, in France it slowed down at 0.2% vs 0.9% prior and in Italy it collapsed at minus 0.5% vs 0.8%. We will have the detailed HIPC contributions published on September 17 by Eurostat but it is safe to say that the slowdown in inflation is mostly due to the reversal in non-energy goods inflation (which represents 26% of the total basket and is split into semi durables, such as clothing and recreational equipment, durables, such as cars and household appliances and non-durables, which refers to pharmaceutical products or newspapers for instance), post-summer sales in most countries and continued downward pressure in services linked to passengers transport (notably regarding airline fares). In most euro area countries, the underlying trend is going down, thus supporting the idea the coronavirus has been deflationary in the short term.
The downward pressure is likely to continue as long as aggregate demand will remain patchy and it could be accentuated, with some delay, by the ongoing appreciation of the euro exchange rate. Over the past three months, the EURUSD cross have increased by more than 7.6% and in trade-weighted terms, the euro is close to record highs. Despite concerns about the spread of the virus in Europe, the strong euro narrative remains prevalent among investors. The exchange rate effect will take a few months to show up in inflation figures but it could translate into a lower inflation of around 0.4-0.5ppt according to our estimates.
In terms of monetary policy, today’s inflation data seriously question the ECB’s baseline inflation scenario and the inflation forecasts from June. It puts pressure on the ECB ahead of the September 10 meeting and will force the Governing Council to adopt a dovish stance to address investors' concerns about lower-for-longer inflation. Taking into consideration these statistics, a stronger euro that does not help, and the increased risk of second wave of the virus in many European countries (see our recent analysis about France’s “exponential” second wave), we think that the question is not whether the ECB will spend or not the entire €1.35tn PEPP envelope, which was a subject of debate among economists a few weeks ago, but rather whether the monetary policy stance is loose enough. Said differently, we still expect that the PEPP envelope will be increased again by year-end, thus confirming that we are not getting out from accommodative monetary policy anytime soon.
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