Eurozone inflation jumps by most in over a decade

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Inflation in the eurozone has shot up to its highest level since the coronavirus pandemic hit last year, ending a five-month spell of falling prices and fuelling investors’ doubts about whether the European Central Bank needs to use more stimulus measures.

Headline consumer price inflation hit an 11-month high of 0.9 per cent in January, up from minus 0.3 per cent in December, according to a flash estimate published by Eurostat on Wednesday. Economists polled by Reuters had only expected 0.5 per cent.

The fastest jump in more than a decade was driven by a combination of one-off factors rather than a revival in underlying demand, as many of the bloc’s shops, schools and leisure venues remain closed due to lockdowns to stem the spread of the virus. 

The reversal of a temporary reduction in German value added tax at the start of this year played a role, as did higher energy costs and supply chain disruptions that have raised container shipping prices for retailers and manufacturers. 

Line chart of headline consumer price inflation (year-on-year % change) showing one-off factors drive rebound in eurozone prices

Analysts expect clothing and footwear prices to be higher in January compared with a year ago owing to delayed seasonal sales while many stores are closed in countries such as France, Italy and Germany. 

Core inflation — stripping out energy and food prices, which are usually more volatile — rose from 0.2 per cent in December to 1.4 per cent in January. 

An annual revision in the weightings used to calculate inflation also pushed up average prices, as more weight was given to products for which demand had increased, such as food, and less to products hit by the pandemic, such as packaged holidays.

Analysts expect the sharp rise is unlikely to be sustained into 2022, even if there is a vaccination-fuelled economic rebound in the second half of the year.

“We expect inflation to drop back again as we think the impact of the pandemic recession will ultimately prove to be disinflationary,” said Andrew Kenningham, economist at Capital Economics.

The ECB forecast in December that price growth would rise from 0.3 per cent in the first quarter of this year to 1.5 per cent in the fourth quarter, before falling back to 1.2 per cent a year later — still below its target of below but close to 2 per cent.

Richard Barwell, head of macro research at BNP Paribas Asset Management, said the ECB was likely to continue “looking through this increase in inflation because they think it is transitory” — adding that after undershooting its target for many years, the central bank would be cautious before reacting to the recent jump in prices.

“I still think in a year’s time, core inflation will be stuck around 1 per cent rather than closing in on the 2 per cent target,” said Mr Barwell. “We had a big fall in unemployment in the eurozone in recent years and that still didn’t lift inflation up to the ECB’s target, so I’m not convinced Europe will escape its low inflation trap so easily.”

Conservative commentators in Germany have long feared excessive inflation and worry that the ECB’s loose monetary policy could cause the economy to overheat. German inflation rose faster than in most of the eurozone in January, climbing from minus 0.7 per cent in December to 1.6 per cent, according to a preliminary estimate published last week.

Analysts at Morgan Stanley said they “continue to see weak underlying price pressures and only a gradual pick-up in core inflation, given the extensive slack in the labour market”, adding that they “expect the ECB to look through and talk down today’s spike”.

Investors seemed unconcerned about the risk of any tightening in the ECB’s policy. Italian 10-year government bond yields responded to the announcement that former ECB president Mario Draghi was set to form a new government in Italy with their biggest one-day fall in eight months, dropping 10 basis points to 0.55 per cent.

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