Negative eurozone inflation rate obscures staple goods’ rising cost

The cost of many goods and services which have become popular with eurozone consumers during the coronavirus pandemic is rising far faster than the bloc’s overall depressed level of inflation, according to an analysis of official data by the Financial Times.

The single currency area entered deflation territory in August according to its headline measure of price change, and European Central Bank president Christine Lagarde has warned that she does not expect to see it return to expansion in the early months of next year.

Economists polled by Reuters expect the headline inflation rate for November to come in at minus 0.2 per cent when it is published on Tuesday.

But this downward trend in prices is partly driven by a drop in the cost of goods and services, of which consumers are either buying less or have stopped purchasing altogether, because of changes in lifestyle due to the pandemic, FT analysis suggests.

For example, the price of car fuel fell 12 per cent year on year in October, air tickets were down 15 per cent and train fares dropped 4.5 per cent. Hotel rooms and international package holidays also became cheaper than last year. But people stuck at home because of restrictions and social distancing measures cannot take advantage of these savings.

Meanwhile the prices of significant regular budget items such as food are increasing by around the ECB target inflation rate of just below 2 per cent. The prices of education, medical services, bicycles and care home services are all also rising on an annual basis.

The analysis suggests that the overall figure which policymakers use to shape their decisions does not fully reflect the way in which many people are experiencing price changes in the real economy.

Marchel Alexandrovich, European economist at Jefferies, said the changes in consumption patterns are “an issue for sure” when it comes to measuring the rate of price growth.

Bar chart of Annual % change in prices (October) showing Low demand drives down prices in many sectors across the eurozone

The eurozone’s main inflation measure is based on what people bought in 2018 and so does not reflect changes in consumer habits forced by coronavirus restrictions this year.

Florian Hense, an economist at Berenberg, said: “This year has greatly added to the challenges statistical offices and central banks had before the pandemic as price collection was impaired at some points and consumption patterns have changed.”

In a bid to take into account the shift in spending patterns, the ECB has calculated an experimental inflation index. It has recorded a reading of at least 0.2 percentage points higher than the headline figure in every month since April. In August, the latest month available, this would have prevented eurozone inflation from falling into negative territory.

Line chart of Annual % change showing Pandemic-led shift in spending boosts stagnating eurozone prices

The experimental measure “by design . . . comes closer to the rate of change in the prices of items actually purchased by consumers during this period”, the ECB said. The alternative inflation measure “intuitively reflects consumers switching from lower-than-average inflation categories, such as fuel for transport, to higher-than-average inflation categories, such as food items”.

The headline rate of inflation is also being held down by the German cut in VAT, which pushed the country’s core inflation — the rate of change in prices excluding energy, food, alcohol and tobacco — down to 0.7 per cent in July, when it was introduced, from 1.5 per cent in the previous month. The effect, which feeds through into the overall eurozone average, is expected to reverse when the measure is lifted in January.

Frederik Ducrozet, strategist at Pictet Wealth Management, said there was “no doubt” that “a number of statistical factors” were pushing the headline rate of inflation lower during the pandemic. The ECB’s alternative index “should provide a better assessment of the actual trend in consumer prices”, he said.

Nevertheless, most analysts agree that the overall impact of the pandemic is deflationary. Among the worst-hit parts of the eurozone are Italy and Spain, where the headline inflation rate is contracting at double the pace of the bloc’s average.

Katharina Koenz, economist at Oxford Economics, said that although many consumers’ experience of price changes was “a touch higher” than the official measure suggests, the overall effect of the pandemic and ensuing recession was “disinflationary”.

The unprecedented shock to output caused by the pandemic has hit demand via job losses, higher precautionary savings and lower growth in pay. Lower commodities prices, particularly oil, have also reduced price pressures.

Weaker demand and some cheaper inputs have put downward pressure on prices, analysts said.

William De Vijlder, economist at BNP Paribas, said that throughout the eurozone the difference in inflation rates across sectors “tended to increase this year” as a result of the pandemic and that “it will take considerable time until activity has been restored sufficiently to generate labour market bottlenecks, which . . . are a necessary condition to see a broad-based and lasting increase in inflation”.

Mr Alexandrovich said that beyond the measurement problems, the pandemic is “clearly deflationary” and members of the ECB’s governing council are “very worried”.

Policymakers will be looking for rising wages as a sign that inflation is on the right path, but this trend is unlikely to materialise in the coming months as the eurozone’s output remains depressed and governments’ unprecedented level of fiscal support for jobs begins to ease off.

“For the ECB if you don’t have wage rises . . . then you don’t have a healthy rate of services inflation and if you don’t have services inflation you don’t have core inflation,” Mr Alexandrovich said.

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