Inflation to stay much lower in euro-zone than US - Capital Economics
European Economics

Inflation to stay much lower in euro-zone than US

European Economics Weekly
Written by Jack Allen-Reynolds
Data published this week confirmed that inflation is extremely weak in the euro-zone, and we expect it to remain well below target in the coming years even as inflation rises above 2% in the US. Next week, the first estimates of Q4 GDP looks set to show that Germany avoided a contraction, but the economies of France and Spain shrank. Declines in GDP in Q1 look very likely too.

It is not surprising that investors interpreted the ECB press conference this week as being slightly hawkish. After all, policymakers seem content with preserving the current level of financial conditions, despite their forecasts suggesting that this will not be sufficient to hit their inflation target. And as it happens, we think inflation will undershoot even the Bank’s below-target forecasts. (See here.)

This is in stark contrast to the US, where inflation seems to be on the rise. Inventories there have plummeted as production has not kept pace with the rebound in consumption. This has driven core goods inflation up to a nine-year high, and exchange rate effects will push it up further. (See here.)

In the euro-zone, surveys suggest that inventories are around normal levels, while data released this week showed that core goods inflation has fallen to a record low. (See Chart 1.) The strengthening of the euro over the past year, which we expect to continue, will add to disinflationary pressure.

Chart 1: Core Goods Inflation (%)

Source: Refinitiv

Admittedly, higher shipping costs and the semiconductor shortage could push up prices of cars, for example. But we think the jump in shipping costs will be short lived. (See here.) And while car price inflation has accelerated sharply in the US, it has fallen to very low rates in the euro-zone.

There are also more fundamental reasons why inflation will remain lower in the euro-zone than the US. The US economy has not been hit as hard by the pandemic, with GDP in Q3 last year “only” 3.4% below its pre-pandemic level. Euro-zone GDP was still down by 4.4% and is likely to have contracted in Q4 and again in Q1.

Despite this, the US authorities are providing far more policy support. The Fed cut interest rates last year, whereas the ECB didn’t, and generous fiscal measures meant that US incomes rose. What’s more, the US looks set for another huge fiscal expansion this year, which will be several times larger than what we are likely to see in the euro-zone.

Bringing all of this together, while we expect core inflation to rise in both economies this year, we think it will settle at over 2% in the US in 2022, but only around 0.5% in the euro-zone.

A return to political crisis in Italy

Even in these strange and difficult times, there are some things that haven’t changed, and one of those is Italy’s propensity for political crises. Much ink has been spilled elsewhere speculating about what might happen next, but two points are worth emphasising.

The first is that while the government has survived, it has been weakened. Without a majority in the Senate, it will be much more difficult to pass budgets in future, which could hamper the government’s ability to provide additional fiscal support.

The second is that the impact on the bond markets has been negligible as the ECB has kept yields within a narrow band. We think yields will fall this year. But that does not mean the bond market is immune to politics. In the event of an early election, there is a risk that there could be a new more Eurosceptic government. In that situation, it could be more difficult for the ECB to keep a lid on yields.

The week ahead

Next week will bring the first estimates of GDP in Q4. We expect the data to show that the French, Spanish, Austrian and Belgian economies all contracted, while Germany eked out a small expansion. Other data are likely to show that economic sentiment worsened in January.


Data Previews

Euro-zone GDP (Q4, 1st est.) Fri. 29th Jan.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

France GDP, q/q (y/y)

06.30

+18.7%(-3.9%)

-4.1%(-7.8%)

-4.0%(-7.6%)

Germany GDP, q/q (y/y)

07.00

+8.5%(-4.0%)

0.0%(-4.0%)

+0.5%(-3.6%)

Spain GDP, q/q (y/y)

08.00

+16.4%(-9.0%)

-1.5%(-10.7%)

-1.5%(-10.8%)

Austria GDP, q/q (y/y)

08.00

+12.0%(-4.2%)

-3.0%(-6.6%)

Belgium GDP, q/q (y/y)

14.00

+11.4%(-4.5%)

-4.0%(-8.8%)

A weak end to 2020 for most economies

Most euro-zone economies are likely to have contracted once again in the final three months of 2020, as the ramping up of virus containment measures will have weighed on economic activity.

Admittedly, the lockdowns imposed during Q4 were more targeted than those introduced at the start of the pandemic last March. Most notably, manufacturing and construction remained open. Monthly industrial production data available to November suggest that output in the sector rose in Q4 in all five of the economies publishing their first GDP estimates next week. (See Chart 2.)

Chart 2: Average Level in October & November
vs. Average Level in Q3 (%)

Sources: Reuters, Capital Economics

But as Chart 2 also shows, in most cases this will have only cushioned the blow from tighter restrictions, not offset it completely. The weighted average of the available monthly hard data suggests that while GDP rose in Germany in Q4, it declined in France, Spain (albeit only marginally), Austria and Belgium. France, Austria and Belgium all closed non-essential retail for parts of Q4.

What’s more, these data do not paint the whole picture. They exclude parts of the economy such as hospitality and entertainment that were significantly affected by the tighter restrictions imposed during the quarter. This will have particularly been the case in Spain, where these sectors account for a large share of GDP. The high frequency mobility data, which have had a reasonably good relationship with economic activity so far, also show a decline in movement in Q4. (See Chart 3.)

Chart 3: Google Mobility Trackers*

Sources: Google, Capital Economics.

Germany appears to have escaped an economic contraction in Q4. The annual GDP number already published implied a rise of 1.2%-1.5% q/q in Q4. But the statistics office has since said that GDP probably stagnated in Q4. On balance, we have pencilled in a small rise, of 0.5% q/q.

By contrast, we think GDP declined by around 4% q/q in France and Belgium, 3% in Austria and 1.5% in Spain. The euro-zone aggregate number will not be published until 2nd February. But all things considered, we think that the region’s GDP will have contracted by around 1.5% q/q in Q4.

Looking ahead, it is clear from the renewed rise in case numbers and strict restrictions in place that there will be no recovery in activity in Q1. Another contraction in GDP seems likely.

Euro-zone Economic Sentiment Indicator (Jan.) Mon. 25th Jan./Thu. 28th Jan.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

25th January

German Ifo BCI

09.00

92.1

91.0

91.0

28th January

Euro-zone ESI

10.00

90.4

90.0

89.0

January lockdown blues

With lockdowns being tightened and extended at the start of the year, economic sentiment is likely to fall.

The Economic Sentiment Indicator rose slightly in December but remained well below its pre-pandemic level. Based on the recent relationship, it looked consistent with GDP falling by about 4% y/y. (See Chart 4.) Sentiment was higher in Germany than elsewhere in the euro-zone.

The survey evidence available for January has been a mixed bag. The investor sentiment indicators produced by Sentix for the euro-zone and by ZEW for Germany both rose. But the PMIs declined, and as they survey businesses, rather than investors, they are likely to be a better guide to the German Ifo Business Climate Indicator (BCI) and the ESI.

Based on the PMI, we suspect that the German Ifo BCI fell from 92.1 in December to about 91.0 in January. The EC’s ESI also includes a measure of consumer confidence, which we already know edged down in January. We have pencilled in a fall in the euro-zone ESI to 89.0.

Sentiment and activity are likely to remain low for the next few months, as restrictions remain in place. As a result, we expect GDP to decline in Q1 after falling in Q4.

Chart 4: Euro-zone ESI & GDP

Source: Refinitiv


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time CET

Time (GMT)

Previous*

Median*

CE Forecasts*

Mon 25th

Ger

Ifo Survey (Jan)

10.00

(09.00)

92.1

91.0

91.0

EZ

ECB’s Lagarde speaks at Davos Agenda

17.00

(16.00)

Tue 26th

No Significant Data Released

Wed 27th

Fra

Consumer Confidence (Jan)

08.45

(07.45)

95

94.0

EZ

ECB’s Lane speaks at virtual conference

16.00

(15.00)

Thu 28th

Spa

Unemployment Rate (Q4)

09.00

(08.00)

16.3%

16.8%

Ita

Consumer Confidence (Jan)

10.00

(09.00)

102.4

EZ

EC Economic Sentiment Indicator (Jan)

11.00

(10.00)

90.4

90.0

89.0

Ger

CPI (Jan, EU Harm., Prov.)

14.00

(13.00)

+0.6%(-0.7%)

+0.3%(+0.5%)

EZ

ECB’s Schnabel speaks at LSE

18.15

(17.15)

Fri 29th

Fra

GDP (Q4, Prov, q/q(y/y))

07.30

(06.30)

+18.7%(-3.9%)

-4.1%(-7.8%)

-4.0%(-7.6%)

Ger

GDP (Q4, Prov, q/q(y/y))

08.00

(07.00)

+8.5%(-3.9%)

0.0%(-4.0%)

+0.5%(-3.6%)

Aus

GDP (Q4, Prov, q/q(y/y))

09.00

(08.00)

+12.0%(-4.0%)

-3.0%(-6.6%)

Spa

GDP (Q4, Prov., q/q(y/y))

09.00

(08.00)

+16.4%(-9.0%)

-1.5%(-10.7%)

-1.5%(-10.8%)

Spa

CPI (Jan, Prov, EU Harm.)

09.00

(08.00)

+0.2%(-0.6%)

(-0.6%)

Ger

Unemployment Rate (National measure, Jan)

09.55

(08.55)

6.1%

6.1%

EZ

M3 Money Supply (Dec)

10.00

(09.00)

+0.7%(+11.0%)

(+11.1%)

Bel

GDP (Q4, Prov., q/q(y/y))

11.00

(10.00)

+11.4%(-4.5%)

-4.0%(-8.8%)

Selected future data releases and events

Mon 1st

EZ

Markit Manufacturing PMI (Jan, Fin)

10.00

(09.00)

54.7p

54.7

EZ

Unemployment Rate (Dec)

11.00

(10.00)

8.3%

Tue 2nd

Fra

CPI (Jan, Prov., EU Harm.)

08.45

(07.45)

+0.2%(+0.0%)

Ita

GDP (Q4, Prov, q/q(y/y))

10.00

(09.00)

+15.9%(-5.0%)

Por

GDP (Q4, Prov., q/q(y/y))

10.30

(09.30)

+13.3%(-5.7%)

EZ

GDP (Q4, Prov., q/q(y/y))

11.00

(10.00)

+12.5%(-4.3%)

Wed 3rd

EZ

Markit Composite PMI (Jan, Fin)

10.00

(09.00)

47.5p

47.5

EZ

Flash CPI (Jan)

11.00

(10.00)

(-0.3%)

Thu 4th

EZ

Retail Sales (Dec)

11.00

(10.00)

-6.1%(-2.9%)

*m/m(y/y) unless otherwise stated. p=provisional. Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q(%y/y) unless stated

Latest

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

2019

2020

2021

2022

GDP

+12.5(-4.3)

-1.5(-5.9)

-0.5(-2.7)

+2.2(+12.6)

+2.2(+2.3)

+1.1(+5.0)

+1.3

-7.0

+4.0

+4.0

Household Spending

+14.0(-4.6)

-2.5(-7.0)

-0.7(-3.4)

+2.5(+13.1)

+2.4(+1.6)

+1.8(+6.1)

+1.3

-7.9

+4.1

+4.8

HICP (%y/y)

-0.3 (Dec)

-0.3

0.0

0.7

0.9

1.3

+1.2

+0.3

+0.8

+0.8

Unemployment Rate (%)

8.3 (Nov)

8.4

8.6

8.8

8.6

8.4

7.6

8.0

8.5

8.0

Depo Rate, end period (%)

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

10yr Bund Yield, end period (%)

-0.50

-0.58

-0.50

-0.50

-0.50

-0.50

-0.19

-0.58

-0.50

-0.50

$/euro, end period

1.22

1.22

1.22

1.23

1.24

1.25

1.12

1.22

1.25

1.30

£/euro, end period

0.89

0.89

0.89

0.89

0.89

0.89

0.85

0.89

0.89

0.89

Sources: Bloomberg, Capital Economics


Jack Allen-Reynolds, Senior Europe Economist, jack.allen-reynolds@capitaleconomics.com