In July, Eurozone headline inflation was flat at the ECB’s target of 2%. This news shocked many who were expecting a modest decrease to 1.9%. That stability came even as the economy provided mixed signals from various sectors. This was due to a continued drift downward in services inflation and an unexpected surge in food and goods inflation.
The ECB’s inflation goal was not overrun due to the fact that disinflation from energy prices was more gradual than anticipated. Food inflation reared its ugly head again, rocketing to a month-to-month 18-month high of 3.3%. The recent energy crisis pushed overall food inflation a staggering 15.5% at its peak. It was an important turning point for the dynamics of consumer prices.
Services inflation fell to a 40-month low of 3.1%. This declining gap is due to normalization of above-average, steady wage growth in the Eurozone. At the same time, goods inflation shocked economists by increasing to a 16-month-high of 0.8%. Despite widespread expectations for it to decrease, goods inflation is on the rise. This is mostly because of lower U.S. demand caused by tariffs and added competition from Chinese imports.
As FXStreet economist Bill Diviney observed, this highlights a world of inflation in sectors that are often trending in the opposite direction.
“On the positive side, services inflation continued its downward trajectory, falling to a 40-month low of 3.1%. The decline in services inflation is proceeding somewhat faster than our expectations, but it is consistent with the normalization we have seen in wage growth and will be welcomed by the ECB. In contrast, goods inflation surprised to the upside, rising to a 16-month high of 0.8%, although this remains a benign figure.” – Bill Diviney via FXStreet
A lot of experts still think that goods inflation is climbing. They forecast it will face renewed downward pressure in the months ahead. On top of that, weak demand from the U.S. is further pressuring the market. At the same time, heightened competition from China is creating a decidedly consumer-friendly dynamic.
Core inflation held firm at 2.3%, in line with market expectations, which suggests that underlying price pressures may be stabilizing. The smaller disinflation in energy surprised us, since that wasn’t what you would have expected based on the previous signals from wholesale prices. Food inflation has jumped, so we need to watch that closely.
“Core inflation was in line with expectations at 2.3%. The drivers of the surprise in the headline figure were less disinflation in energy than had been signaled by wholesale energy prices, and a renewed pickup in food inflation, which rose to an 18-month high of 3.3%.” – Bill Diviney via FXStreet
We know households are very sensitive to changes in food prices. This sensitivity renders the food sector a particularly powerful actor in shaping long-term inflation expectations. Furthermore, the ECB recognizes that changes in food prices can indirectly impact general economic sentiment and consumers’ propensity to buy.
Diviney told the CSG Fellows he felt cautiously optimistic about the current inflationary environment.
“Overall, the ECB’s Governing Council will be comfortable with the July report. While food inflation is an emerging concern, it remains to be seen if the recent pickup will be sustained, with little sign of strong upward pressure from global agricultural commodity prices.” – Bill Diviney via FXStreet
The ECB is expecting inflation to drop below its 2% target in the next few months. Underlying this shift is a drop in oil prices and the appreciation of the euro. This forecast is further confirmation that core inflation rates are heading in the direction of normalization. The economic landscape is rapidly changing in reaction to increasing and varied outside pressure.