ECB Will Welcome Higher Core Inflation --- Heard On The Street

By Richard Barley
        Will the real eurozone inflation rate please stand up? Headline inflation remains ultralow at 0.2%, data released Friday showed. But under the surface, there are some signs emerging that inflation is picking up.

        True, July's headline inflation reading remains a long way adrift of the European Central Bank's target of "below, but close to" 2%. But this rate is still being distorted by swings in energy prices, which saw a renewed move downward in July. By contrast, the so-called core rate of inflation, which excludes volatile prices for energy, food, alcohol and tobacco, rose to 1%, the highest since April 2014. Meanwhile, non-energy industrial goods inflation has risen for five consecutive months and at 0.5% now is at its highest since June 2013.

        The bounce in core inflation may not yet be sustained: the data can be volatile. But it is encouraging in suggesting that a persistent bout of deflation, where falling prices lead to the expectation that they will fall further, is ever more unlikely.

        The ECB still faces challenges. Market expectations of inflation over the medium-term, while well off their lows, have recently softened somewhat, with inflation swaps estimating the five-year inflation rate in five years' time dipping back below 1.8%.

        But financial markets may be driven too heavily by short-term movements in commodities prices, making the importance of this indicator questionable--even though it was fingered in 2014 by ECB President Mario Draghi as being a key factor in the monetary policy debate. And July's core inflation number came as a surprise to bond markets: German 10-year yields spiked higher Friday after the data was released.

        Perhaps the most important thing, however, is that low inflation isn't posing a challenge for consumers. Indeed it is helping deliver a boost to consumers' pay packets and spending power. Eurozone wages rose 2.2% in the first quarter of 2015 from a year earlier, and retail sales have been rising steadily. That is countered, however, by the fact that unemployment remains stubbornly high, at 11.1%.

        The ECB said in its economic bulletin this week that it was too early to declare a turning point in inflation trends in the eurozone. July's numbers aren't the smoking gun on this issue. But the ECB is still likely to take comfort from them.

        Write to Richard Barley at richard.barley@wsj.com

        (END) Dow Jones Newswires

        July 31, 2015 09:57 ET (13:57 GMT)

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