Euro area inflation readings to bounce on base effects

With a still negative output gap and sustained disinflation in commodity prices, the European Central Bank (ECB) rightfully remain concerned over price pressures. Headline inflation slipped back towards the 0% mark in the December quarter after a brief rebound in 3Q. The energy price index has declined in past 26 out of 31 months, decelerating at a faster pace this year. Jan-Nov energy price index is down 7.0% YoY compared to last year's -1.9%. 

Impact of the collapse in commodity prices has however been partly offset by pick-up in food, non-energy goods and service sector pressures. Into 2016, there will be some reprieve on deflationary concerns. Firstly, core inflation stabilized around 0.9%-1.0% in 4Q and is expected to inch higher as aggregate demand picks-up. There are indeed signs that domestically-generated inflationary pressures are off the trough, as seen by the GDP deflator rising in recent quarters.

In addition, base effects are also likely to perk next year's inflation. From an estimated 0% YoY this year, inflation is expected to tick up to 0.8% in 2016. 2H inflation will hold above 1%, temporarily addressing deflation worries. Despite the uptick, the ECB's 2% target for inflation remains out of reach. This will see the European Central Bank sound and act dovish in the year ahead.