RaboResearch - Economic Research

Eurozone inflation cannot keep up with strong economic growth

Economic Comment

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  • Economic growth in the Eurozone exceeded expectations in the third quarter of 2017
  • We are likely to revise upwards our Eurozone GDP growth outlook for 2017 from 2.1 percent to 2.3 percent
  • Despite the positive economic backdrop, core inflation is unlikely to reach the levels the ECB would deem 'durable and self-sustaining'

Positive growth surprise does not alter overall view

The Eurozone economy grew by 0.6 percent in the third quarter compared to the previous quarter, exceeding expectations. Quarterly growth in the second quarter was revised upwards by 1 percentage point to 0.7 percent. Of the large Eurozone countries only France and Spain have published growth estimates for the third quarter so far; their economies grew by 0.5 percent and 0.8 percent respectively, a moderation of 0.1 percentage point from growth in the second quarter. In both countries domestic demand was the main growth driver.

Going forward, the higher than expected growth figure in the third quarter does not change our view of strong yet slightly diminishing economic momentum and moderately increasing headwinds. Mainly on the back of somewhat lower employment growth and pent-up demand, consumption growth is set to slow a bit in 2018. The stronger euro and weaker activity in the UK are expected to slightly temper export growth as well. That said, due to the higher than expected numbers for the second and third quarter, we are likely to ‘mechanically’ revise upwards our Eurozone GDP growth outlook for 2017 from 2.1 percent to 2.3 percent, and possibly from 2.0 percent to 2.1 percent in 2018, during our next forecasting round in November.

Figure 1: Upward revision Eurozone economic growth forecast likely
Figure 1: Upward revision Eurozone economic growth forecast likelySource: Rabobank, Macrobond, NiGEM
Figure 2: Core inflation drops to below 1 percent
Figure 2: Core inflation drops to below 1 percentSource: Macrobond

Inflation cannot keep up with economic growth

Despite the positive economic backdrop, inflation for October came in lower than expected. The headline slowed down 0.1 percentage points to 1.4 percent in September, but the core measure fell quite sharply to 0.9 percent from 1.1 percent the previous month. That is the lowest core inflation rate since February this year (and only 0.3 percentage points above its ‘all time low’ set in March 2015). A sharp drop in core services prices could point to transitory factors but it does not take away from the fact that even in Germany, where unemployment is at record lows and vacancy levels at record highs, there is still modest wage growth and hardly any underlying price pressure. These data underscore the point that as long as a significant uptick in wage growth remains absent, core inflation is unlikely to reach the levels the ECB would deem ‘durable and self-sustaining’. We have argued before that we see little reason to believe that wage growth will pick up strongly in the short term, as it is being held back by structural factors. And while positive, the fact that Eurozone unemployment has fallen to below 9 percent for the first time since early 2009 does not change that view.

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