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Rising shipping costs and lengthening delivery times have
reignited the discussion about a return of reflationary
forces.
Business surveys in the eurozone industrial sector have started
to point to some upward pressure on factory gate prices and
potentially core goods prices.
However, it is way too soon to shift the focus from deflation
to reflation risk in the eurozone, not least with a double-dip
recession in train.
Disinflationary trends have been entrenched for a decade and,
looking beyond some near-term transitory upward pressures on
inflation, are likely to persist.
Recent reports of substantial increases in container shipping
costs and some supply chain issues, reflected in lengthening
delivery times in IHS Markit's PMI data, have reignited the
reflation versus deflation debate within the economics
community.
Even in the eurozone, there are signs here and there that
pipeline price pressures are picking up. Surveys of selling price
expectations among industrial firms started to rise in autumn 2020,
in line with the strong rebound in manufacturing activity. The
latest European Commission survey for December 2020 showed a marked
pick-up, indicative of some upward momentum in core producer price
inflation.
Perspective is required, however. The pick-up in PPI inflation
is coming from very weak levels. The headline y/y rate of change
has been negative since mid-2019, well before the pandemic, while
the y/y rate of change excluding energy was zero as of November
2020. Moreover, while both rates will rise, whether higher factory
gate inflation will pass through significantly into consumer prices
is debatable given the difficult demand backdrop.
As yet, there is little sign of this happening. In fact,
eurozone HICP inflation for non-energy industrial goods slipped
further into negative territory in December 2020 (to -0.5%). Profit
margins may take the strain given the tough economic climate.
December's HICP data delivered a surprise in a negative
direction in fact, with the headline inflation rate unchanged at
-0.3% for the fourth month in a row despite upward pressure from
energy, as prior oil price gains feed through.
Eurozone HICP inflation is set to rise in early 2021. In
January, we expect the end of reduced VAT rates in Germany to push
headline inflation up by around a quarter of a percentage
point.
From February to May, upward base effects from energy prices are
also likely to lean up on the headline inflation rate (subject to
crude oil price dynamics in the coming months), given pronounced
COVID-19-driven declines in oil prices in the equivalent period of
2020.
Also, some of the HICP items which have been most affected by
the COVID-19 pandemic might also rebound as economic conditions
improve later in 2021 once the restrictions ease. These include
prices of clothing and footwear, package holidays, accommodation
services and passenger transport.
However, we need to look beyond short-term transitory
influences, to focus on the drivers of underlying inflationary
pressures. These include wages and unit labour costs which, in
turn, drive services inflation which is the predominant influence
on overall HICP inflation.
Combine the eurozone's exceptionally large output gap (which is
about to rise substantially further given the recession we forecast
in Q4 2020 and Q1 2021), the likelihood of further rises in the
unemployment rate and persistent low inflation expectations and the
prospect of a sustained, wage-driven pick-up in inflation looks
remote.
Add in the lagged effects of exchange rate appreciation, with
the euro having risen to a record high in trade-weighted terms late
last year, and we doubt that the reflationary arguments will endure
for long beyond the expected pick-up in the months ahead.
Consider the starting point for HICP inflation rates too.
December 2020's final HICP figures confirmed the headline inflation
rate below zero for the fifth straight month (-0.3%) and the
traditional core rate at record lows, only marginally above zero
(0.2%). IHS Markit's "super core" measure of inflation dropped back
to its record low also (0.9%). It includes only the HICP items
sensitive to the eurozone output gap, so ought to be more
reflective of domestic economic trends than global influences.
Moreover, in December 2020, the share of eurozone HICP items
exhibiting negative y/y rates of change was close to its record
high, at just under 40%.
With the exception of a short-lived, energy-propelled spurt in
2018, inflation in the eurozone has been well below 2% for nigh on
a decade. Disinflationary forces look well entrenched and
forecasters should be wary of getting ahead of themselves. The
pick-up in eurozone growth from 2014/15 onwards was widely expected
to yield higher inflation and higher ECB policy rates. Neither
materialised.
We expect deflationary concerns in the eurozone to persist and
we will continue to assess these risks via the broad range of
inflation metrics we monitor in our Deflation Risk Dashboard.
Posted 27 January 2021 by Ken Wattret, Vice President, Economics, S&P Global Market Intelligence