Eurozone: Growth is buoyant, inflation struggles to accelerate – Standard Chartered

The analysis team at Standard Chartered explains that Eurozone surveys continue to show that activity is running close to six-year highs as the PMI composite reached 56.4 in March, while the Economic Sentiment Index reached 107.9, both at the highest level since 2011 and implying growth rates of 2.0-2.5% y/y. 

Key Quotes

“That said, inflation does not show convincing signs of returning to target in a sustainable fashion. Headline inflation accelerated significantly in Q1, to 1.8% y/y three-month average). But core inflation remains little changed, below 1.0% y/y, showing that any acceleration is likely due to higher energy and food prices compared to one year ago. For underlying inflation to accelerate in a sustainable way, the euro area’s output gap has to close. Core inflation has been below 2.0% since 2002, which is a sign that unless higher prices of energy and food feed through to higher wage demands, the ECB may have to keep monetary policy very loose for an extended period.”

“The scale of the euro area’s recession means that growth at the current pace of 1.52.0% y/y for a few years is needed before spare capacity is absorbed. Growth is now well above the trend rate of growth, which is c.1.0-1.2%. The unemployment rate is coming down but remains about 2ppt above the pre-2008-09 global financial crisis (GFC) level. A measure of unemployment close to the U6 measure used by the US Fed, which is a broader measure of unemployment (counting discouraged workers and part-time workers who would like to work full time), shows euro-area unemployment to be 4ppt higher than where it was pre-GFC.”

“Moreover, wage growth shows few signs of picking up. In Germany, where the output gap is almost closed, nominal wage growth is c.3% y/y. For the euro area, wage growth remains c.1.5% y/y. Unless euro-area wage growth accelerates to c.3% y/y, it will likely be difficult for inflation to reach the target in a sustainable way.”

“The credit cycle also appears to be losing steam. Credit to the private sector has accelerated to six-year highs after a long period of private-sector deleveraging, but credit growth has recently stalled at c.2.0% y/y. The bank lending survey for Q4-2016 showed that net demand for loans remained positive but softened.”