Weaker Eurozone Inflation Poses Downside Risk For EUR

• Eurozone inflation may surprise on the downside given the national inflation development
• Lower core inflation justifies dovish ECB QE taper weighing on EUR

With inflation data across Eurozone tilted to the downside, the risk of core inflation in the currency area reverses to the downside adding pressure on the ECB to keep monetary stimulus for longer will weigh on EUR.

German inflation figures for the month of October came in softer than expected. The headline HICP inflation in Germany decelerated surprisingly to 1.5 percent y/y in October from September’s 1.8 percent y/y. Consumer prices rose 1.1 percent y/y in France, picking up slightly from 1.0 percent y/y in September. Inflation was also down in Spain to 1.7 percent in September. 

The set of national inflation data in Eurozone confirms softer inflation pressures, especially in Germany, indicating that the euro area inflation might have decelerated to 1.4 percent, compared with the prior forecast of a rise to 1.6 percent.

The data from Germany showed that price rises were subdued and annual inflation decelerated in almost all of the sectors with services rising just 1.2 percent, compared with September’s 1.6 percent y/y increase.

Temporarily softer core inflation reading for September in both Germany and Eurozone might prove to be a prolonged, not just one-month factor.  The upward trend in core inflation seen earlier in 2017 has taken a breather and the core inflation development is now being tilted to the downside increasing risks of downside revision of current inflation projections.

Within the environment of low inflation, monetary policy can afford to be ultra-easy with interest rates being lower for longer, confirming that the dovish taper of the QE program by the ECB last week was a cautious decision. Should trend in the headline, but more importantly in core inflation reverse and point to the downside, the ECB can afford to extend the asset purchase program most possibly until the end of next year with first rate hike possibility moved further into the future beyond the horizon of Q2 2019.