Euro area inflation: Target looks closer, but it’s still far off

Barclays continues to expect headline HICP inflation to average +0.1% this year and +1.0% next, and core HICP inflation to edge up to 1.1% next year from +0.8% in 2015. Looking ahead, the bank forecasts both headline and
core HICP inflation to accelerate, but only modestly, and consistent with headline consumer prices hovering about 0.5pp off the ECB medium-term inflation target: headline inflation to average +1.5% in 2017 and core prices to stabilise at +1.3%. Future developments will largely depend on domestic demand recovery prospects for which accommodative policy will play a critical role, as well as the extent to which further structural reforms aimed at liberalising some sectors in the economy will reduce rents and dampen inflation.

Why additional easing is needed to support core inflation? "Additional easing aimed at further weakening the currency is needed to counteract external disinflationary pressures – says the bank – which have intensified lately and could weigh on the outlook for non-energy industrial goods (NEIG) prices". Moreover, while acknowledging that annual nominal wage growth reverted in first six months, Barclays thinks that monetary policy will have to remain accommodative for longer in order to keep on supporting the salary recovery and, with that, core inflation. Still large cyclical unemployment and rising labour force participation which over the past few years have been primarily led by women and the elderly (55+) will likely dampen the projected wage recovery. "While we expect it to unfold at a very moderate pace, we think that it could potentially halt should benign financial conditions stop supporting consumer disposable income and corporate spending decisions too early", says Barclays.