Headline Eurozone inflation failed to pick up as expected in the final reading for November and at -0.3% y/y remains firmly stuck in negative territory. Germany’s temporary VAT cut and base effects from energy prices remain the main driving factors for now, and there is also growing acknowledgment that changes in consumption patterns during the pandemic render official HICP numbers less reliable than usual. Together with the prospect that vaccination programs can start soon, that means the ECB’s policy recalibration next week may disappoint those that expect another easing bonanza.
Eurozone HICP inflation was confirmed at -0.3% y/y in the preliminary reading for November, unchanged from October, and with the headline rate failing to lift as expected. Inflation remains stuck in the negative territory then and not just thanks to base effects from oil prices and the temporary cut to the German VAT rate. The pandemic clearly has driven out inflation differentials sharply across the Eurozone, which is not making the central bank’s task any easier.
At the same time, headline inflation rates are far less reliable than usual thanks to the pandemic. On the one hand price collection had been impaired during the strictest part of lockdowns in particular. Even over the summer, when hospitality and tourism operators were allowed to re-open, they were subject to special measures, which on the one hand increased costs, on the other reduced capacity and thus prospective income. With a large part of the services, sector closed once again, price collection once again is a major problem.
At the same time, it is clear that the pandemic triggered sizeable and unusual changes in spending patterns, which are not sufficiently reflected in current CPI or HICP calculations. These indices are compiled using consumption weights that are kept constant within a given calendar year, and currently, HICP weights reflect household consumption patterns measured in 2018. Usually spending patterns change gradually, which means the HICP is sufficiently accurate to reflect overall developments and the impact on disposable income and inflation expectations.
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Thanks for Covid-19, however, spending patterns have shifted substantially with the ECB highlighting that “several studies have identified large spending across product categories”, which is hardly a surprise. As a result, there is a growing gap between CPI type inflation figures and the inflation rate that would reflect price changes in products that are actually purchased by consumers at the moment.
New Monthly CPI
Based on data for nominal turnover and relative weights, ECB staff has estimate a new monthly consumer price index. The projection shows that inflation measured by this “experimental index” has been running higher than HICP inflation, but also that “the difference has remained broadly stable in a recent month”. The gap started to open up in March when lockdowns came into effect. Fuel prices, which have been depressed by base effects from lower oil prices, became less important as travel was restricted, and more people worked from home.
Food prices on the other hand lifted not just because demand picked up, but also because travel and border restrictions caused some logistical problems. Furthermore, farmers in countries such as Germany often experienced problems recruiting a seasonal workforce that largely comes from abroad.
The differences between the two measures are not sufficiently large to really change the picture, as even when taking into account the headline rate would remain firmly below the ECB’s target. However, together with the fact that in the low-interest-rate environment and with house prices still rising in some parts, they highlight that the HICP does not give the full picture when assessing perceptions of inflation, which in the past tended to be higher than official data suggested.
A survey conducted by the European Commission previously showed that households believed that inflation averaged nearly 9 percent between 2004 and 2015, while in reality, the average inflation rate has been around 1.7%. Together with the fact that the headline rate is currently driven by base effects from energy prices and the temporary cut in the German VAT rate, which will fall out of the equation, all this does suggest that there is a limited risk that negative headline rates will become entrenched.
The HICP rate may be -0.3% officially, but the ECB seems far away from a deflationary spiral, even if airlines and travel companies desperately try to keep things going by cutting fares and prices. Together with the prospect of vaccination programs that could start at the end of the year, or early next year at the latest, this means there will likely be a debate over the need to add to measures at next week’s council meeting.
As Governing Council member Schnabel suggested yesterday, this is not the time to reduce stimulus, but it may also not time to add much more. So PEPP and TLTROs – the ECB’s targeted loan program – will be extended, but those hoping for another stimulus bonanza may be disappointed. Not that some would like more drastic steps. An Italian government adviser recently even suggested that the ECB should just write off pandemic debt accumulated at the national government level and bought up by the ECB. Even French central bank head Villeroy, who in the past has been calling for a permanent PEPP program, dismissed that idea, but the suggestions highlight that once the focus switches back to the explosion of debt that has been the result of crisis measures, political pressure on governments will increase substantially.