Eurozone inflation falls further below zero

Headline inflation fell from -0.2 to -0.3% in September. The decline was driven by a drop in core inflation, which fell further from 0.4 to 0.2%. It has to be said that this has been caused by a smorgasbord of temporary factors though, although all of those together do add to the risk of inflation staying lower for longer.

The German VAT reduction is responsible for a significant part of the downward pressure, which is of course a transitory effect, and energy prices also continue to contribute to the downturn. Besides that, goods prices have been influenced significantly by a shift in the timing of the mandatory sales period in some eurozone economies. The dip that this caused in August was followed by a further decline in September, meaning that there is a delay in the reversal of the sales effect.

Perhaps the most worrying decline in the inflation rate comes from services inflation, which usually shows very little volatility and is a large component of the core inflation index. Services inflation was 1.6% in February and has dropped to just 0.5% in September. We find that this is predominantly due to large drops in prices for services related to social distancing, indicating that the coronavirus has had a significant deflationary impact.

For the European Central Bank, most of these factors ordinarily should not cause a change of direction. Still, core inflation this low is hard to ignore, especially since President Lagarde has recently put a lot of emphasis on the importance of the core measure. Also, the second round effects of low inflation for quite some time could become a factor for the medium-term expectations, which is enough for the doves to argue for more stimulus in December.