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Eurozone’s headline inflation temporarily returns to target due to higher oil prices as it surged to 1.9% y/y in May from 1.2% y/y in April and thus reached the ECB’s target of close to but below 2%.

Key Quotes

“Core inflation increased to 1.1% y/y from the extremely low 0.7% y/y in April.”

“The high headline numbers are not that surprising given the  Spanish and German numbers that were released yesterday and the French numbers that were released earlier today, but they are  much higher than expect before the releases of individual country numbers. Core inflation was slightly higher than our expectations.”

“Energy prices are the main reason for the increase in headline inflation, contributing by as much as 0.6% points to the rise.”

“The rise in core inflation in May proves that the April weakness was due to temporary factors, probably related to the timing of Easter, and especially the package holiday prices are likely to have rebounded and contributed to the rise in service prices in May. Thus, the overall picture of sluggish core inflation is not changed and we do not revise our forecast for  core inflation (1.1% in 2018 and 1.4% in 2019).”

“Looking ahead

Energy prices are likely to keep headline inflation elevated for some months, but its contribution will gradually slow and even turn negative, if oil prices are to follow the path implied by the oil futures.

Annual core inflation will remain around the current levels until autumn, where we expect to see a gradual rise to a level of around 1 ½%, which has not been seen for five years. However, in monthly terms core inflation is expected to show a gradual acceleration already in the coming months.

The low core inflation projection is the main reason why we expect the ECB to extend its QE programme from the current EUR 30bn per month until September, by EUR 15bn per month for six more months.

In our baseline, we expect this decision to be taken at the July meeting in order for the ECB to have as much information as possible.”