Eurozone inflation has accelerated to 2%yoy in recent months, matching our expectations and proving high enough for the ECB to slowly exit the quantitative easing programme, but not high enough to rush into a rate hike any time soon. We have updated our estimates to reflect the cut in the Eurozone GDP growth that we introduced last month, on the back of the growing trade tensions globally. In our view, slower economic activity is likely to reduce the inflationary risks ahead somewhat but, at this juncture, much will depend on commodities prices, food in particular, in our view. The chart below shows the effect of having food price inflation modestly faster than currently (2%yoy in July), at 2.5%yoy on average for the coming 18 months, while having food inflation close to zero. We assume that the output gap will continue to widen, the Euro/dollar will remain unchanged at the current level and wage growth will accelerate, given the low unemployment rate. With food inflation modestly faster than currently, Eurozone inflation is likely to stay above the ECB’s target in the coming year, dropping below 2% at the end of 2019E; while, with no food inflation at all, it should soon find a peak.
In our view, the ECB is cornered at this juncture: it cannot afford to tighten monetary policy faster than the current guidance as it would lead to a rapid appreciation of the Euro, speeding up the growth deceleration; at the same time, it does not have enough evidence to switch to an even more dovish stance. In our view, in 2019E, the real driver of monetary policy in the long run will be the political changes taking place in the EU, as those are likely to dictate the prospects for fiscal and trade strategies.