With Christine Lagarde fully committed to the policies inherited from Mario Draghi, it is not surprising
that the majority of data releases at the moment barely get a second look. Our own view for 2020 is that
the euro area economy will outperform expectations. But the incoming data also indicate that the
manufacturing sector had not seen a meaningful recovery at the end of last year which means that Q4 GDP
growth is unlikely to be materially stronger than the 0.23% QoQ rise recorded in Q3. This week’s European
Commission survey for instance helped illustrate the contrasting nature of the current releases with the
sentiment readings for industry stuck close to multi-year lows, while those for services, construction
and retail – although below the peaks reached in 2017 – are consistent with growth at trend, or perhaps
even slightly above.
Just as there may be some confusion over the survey and
output data, the same is true for developments related to inflation. Back in early December we were
struck by how downbeat the ECB’s latest quarterly forecasts were on the medium-term outlook for core
inflation, with forecasts for 2022 (of 1.6%) being the weakest the ECB had ever published in terms of its
3-year out view. Whether this was partly done to help justify the ECB restarting QE at a time when the
macro figures were already turning the corner, a way for Lagarde to put her own stamp on the forecasts, a
genuine assessment that for structural reasons it is now harder to hit the inflation target, or a
creative sleight of hand which gives the ECB space to revise up its forecasts when it is ready to move
policy back to neutral, is up for debate. However, what made the timing curious is that the ECB’s
downgrade came at a time when the inflation data in the euro area were starting to give reasons for
optimism. Even before core inflation printed at 1.3% on consecutive months in November and December, we
were flagging-up firmer trends in ‘super core’ inflation (less volatile and more indicative of
domestically generated inflation) and, based on our Deflation Monitor analysis, the fact that an
increasing share of the euro area’s inflation basket was registering price rises of above 2% YoY.
Somewhere in the system pricing pressures were building, even if the markets didn’t take much notice.
So, where to from here? When it comes to both inflation and to wages, the early
months of the year are critical in setting the direction of travel. For core inflation, January is a
month which sees by far the largest drop in prices at any point in the year. In a sense, therefore, the
question for this month is how strong the Christmas shopping season was, what inventory retailers still
have to shift and how aggressive they will be in discounting prices. It is interesting to observe that
the depth of price cutting in the euro area was reached in January 2015, with prices falling by less and
less in the subsequent Januaries (and the annual rate of core inflation rising slightly in January 2016,
2017, 2018 and 2019).
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