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Oil Makes Eurozone Inflation a Slippery Prospect

MARKETWATCH 9:24 AM ET 11/28/14

So much for the hoped-for bounce in eurozone inflation in the fourth quarter. Falling energy prices--even without taking account of Thursday's collapse in the oil price--have put paid to that. Eurozone inflation in November was just 0.3% and looks almost certain to go lower in the near future.

That of course will raise expectations that the European Central Bank will go further in extending its asset-purchase program. This week Vice President Vitor Constancio said the ECB could consider government-bond purchases in the first quarter of next year.

But away from energy prices, inflation has been broadly stable over the last six months, at least in comparison with its sharper declines in 2012 and 2013. Core inflation--excluding energy, food, alcohol and tobacco--at 0.7% in November was just below its six-month average of 0.8%. The same is true of services prices, up 1.1% versus a six-month average of 1.2%, and industrial goods, flat versus up 0.1%.

The ECB still has to worry both about headline inflation and expectations. The risk from lower oil prices is that headline inflation could fall to zero or below in the near term. But the outlook for eurozone growth given a 27% fall in Brent crude so far this year has also brightened, especially when coupled with signs of improving business and consumer confidence, and easing constraints on credit.

Expectations too seem to be being shaped by oil prices. The five-year/five-year euro inflation swap, a measure of longer-term expectations watched by the ECB, has declined in line with the fall in oil, RBS notes.

That raises the question of what would happen if oil prices were to recover--even by a relatively small amount. If inflation expectations are being mainly driven by oil--which could be true for consumers as well as markets, given that frequently-bought items such as fuel tend to have a bigger impact on perceived inflation--then a rebound could yet change the picture rapidly for the eurozone.

Higher oil prices may be a way off yet, however. That leaves the ECB grappling with the disinflationary impact of oil set against its stimulative effect on growth. Oil could send the ECB skidding toward the government-bond purchases it has so clearly sought to avoid.

Write to Richard Barley at [e-mail]

-Richard Barley; 415-439-6400; [e-mail]

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11-28-140924ET
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