Euro area inflation: recovering, not exploding

In breve

Inflation is back on the radar sceen. Following a decade of persistently low inflation in the advanced economies, markets have now started to flirt with the idea that the lowflation environment will be overcome.
Focal Point

Highlights:

  • Euro area headline inflation spiked in January to 0.9% yoy, after it had been in negative territory since August 2020.
  • This strong jump was driven by one-off factors, like the end of the temporary German VAT cut, cold weather in Spain, a postponement of French winter sales, a re-weighting of the consumer basket and a lower drag from energy prices.
  • While base effects, rising energy prices and the German VAT normalization will lift 2021 inflation in the euro area to 1.5% yoy, underlying inflation pressures will remain muted. The output gap will not be closed before the end of 2022 and there is a substantial crisis-induced slack in the labour market.
  • Against this backdrop we see potential for inflation expectations to trend up further but not to soar. We expect the ECB to look through these short-term factors and to maintain a highly accommodative policy stance.

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Focal Point ǀ Euro area inflation: recovering, not exploding

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