Euro Area Inflation: A Very Slow Burn
Euro area consumer prices increased at a 2.4% annual pace in May, down 0.2 ppt from the 2.6% pace in April. Core inflation fell to 1.8% in May from 1.9% in April. Headline and core inflation peaked in the fourth quarter of 2011, and disinflation is underway.
The 0.6 ppt differential between headline and core inflation is explained by energy and unprocessed food prices. In May, the energy component in HICP (harmonized index of consumer prices) fell 1.4% over the month and posted a 7.3% pace compared to May 2011. Energy prices peaked in April 2012, but base effects will prop up headline inflation through early 2013 even if energy prices go unchanged over the near term. That means headline inflation could be sticky for some time above 2%. But core inflation is not.
President Draghi often speaks of the upward pressure on inflation stemming from tax hikes across the various fiscal austerity programs. Stripping out the tax effects (this data is provided by Eurostat), the theoretical inflation rates in Portugal and Italy are 1.8ppt and 0.8ppt, respectively, below the headline rate. The downward pressure on inflation may quicken through next year, as the effects of VAT and various tax hikes wear off across the region…barring a miraculously robust economic recovery, of course.
(Note: In the chart below, the black line represents 0% difference between headline inflation and tax-adjusted inflation. For orange triangles above the black line, headline inflation is above tax-adjusted inflation, i.e., taxes are boosting aggregate prices.)
Inflation takes time to build, so this disinflationary trend is unlikely to change anytime soon without significant policy accommodation.