Eurozone inflation to take a hit from the rising euro - HSBC

The euro’s appreciation could knock around 0.75ppts off the Eurozone inflation rate next year and the impact might not unwind significantly until 2019, giving the ECB a reason to remain dovish, according to Chris Hare, Economist a HSBC.

Key Quotes

“The euro has appreciated about 7% in trade-weighted terms since early April. Our FX strategists’ forecasts suggest that a marginal further appreciation is in store.”

“ECB analysis suggests that a 1% trade-weighted euro appreciation should lead to a 0.23% decline in the level of the CPI with the effect coming through over two to three years. Based on these estimates, we believe the recent rises in the euro could knock up to 0.75ppts off the inflation rate and that a significant drag will persist throughout next year.”

“We only have forecasts to end-2018, but our framework suggests that the inflation rate will only start to pick up materially in 2019 as (i) the exchange rate drag eventually begins to fade; (ii) the elimination of labour market slack pushes up wage growth; and (iii) ‘unexplained’ (according to our framework) inflation weakness disappears.”

“One upside risk, two downside risks

There are risks to our inflation forecast: one upside risk relates to the exchange rate effect. That is, firms might not pass lower import prices on to consumers but instead take the opportunity to boost their margins. The downside risks relate mainly to domestic inflation: One is that the tightening labour market might continue to fail to exert much upward pressure on wages. Another is that some of the recent ‘unexplained’ inflation weakness could persist.”

“Reason to remain dovish

With inflation likely to remain well under the ECB’s target of ‘below, but close to’ 2%, we see little reason for it to tighten monetary policy. Indeed, we expect the ECB to taper its quantitative easing (QE) programme over the course of next year, but we do not expect any rate rises this year or next.”