Euro area low inflation recovery on track

The euro area recovery continues, but headline inflation remains close to zero. Alongside weak foreign prices pressures, a protracted large output gap continues to weigh on wages and ultimately underlying inflation. 

"A sustained recovery in domestic inflation will be therefore conditional on real activity, as indicated by the Phillips curve which we believe is still a valid analytic tool - even if globalisation has made inflation more responsive to global rather than domestic developments - in line with the recent Jackson Hole speech made by ECB Vice President Constâncio. Our modified version of the curve indicates, in fact, that underlying prices are still negatively correlated with labour market developments", says Barclays. 

The increase in long-term unemployment that has unfolded in the euro area since 2008 (+9.7pp) has been accompanied by a sharp decline in core inflation. Alongside other labour market developments such as the return to a negative slope of the euro area Beveridge curve and the ongoing rise in labour force participation rate, the negative slope of the Philips curve seems also to suggest that the sharp rise in long-term unemployment was mainly cyclical. Core prices remain fairly responsive to domestic economic changes, while the still high level of labour market slack continues to exert meaningful pressures on wages, notes Barclays. In other words, the skills of those who have been long out of the market have neither faded nor have become less applicable to available jobs.