Eurozone inflation returns below zero

Inflation in the euro area returned below 0% in August, ending a run of four successive months of positive inflation since May. The fall to -0.1% yoy from 0.1% in July marks a second straight drop that coincides with the 15% plunge in Brent crude prices since July (-21% in euro terms) and the 9.3% fall in FAO world food prices in August. Today's inflation figures will not come as a surprise to the ECB, which earlier this month warned that a fall back below zero could not be ruled out.

"It is doubtful that the central bank will rush to launch QE2 at the next meeting on 22 October. Our economists' call is for QE expansion in March 2016. EUR 10y IRS are trading 5bp higher today from yesterday's 0.9345% low thanks to stronger Eurostoxx and tighter iTraxx Main and X-over credit indices", says Societe Generale.

 The ECB had already revised down its inflation forecasts by a cumulative 0.7ppts for 2015- 2017 in the updated staff projections published earlier this month. The central bank will take some solace from the fact that core inflation is not falling back and has in fact been stable at close to 1.0% since May. SG Economics expects euro area inflation to average 0.2% in 2015 and 1.1% in 2016, while the core rate should average 0.8% in 2015 and 1.2% in 2016. This means average inflation for 2014-2015 is set to have dropped spectacularly to 0.0% from 1.5% in 2012-2013.

 The risk of a return of euro area inflation to negative territory was flagged by the shock falls in German and Spanish inflation yesterday, but the decline should not be confined to the euro area alone. The collapse in energy and other commodity and global food prices, on top of the depreciation of the currencies of commodity exporting and emerging markets countries, means that global inflation trends in developed economies are likely be very benign in the coming months.

 This has already led central banks to ease rates lower where possible (Norway and India). Others could follow. The Fed (and BoE) are on a different plane, however, and FOMC officials have over the past week tried to correct expectations by supporting the case for a first rate increase by year-end.

"The fall in US 5y break even inflation below 1.0% yesterday for the first time since 2009 (-15bp since the last FOMC meeting) shows that investors see very little chance of inflation returning to the 2% target as the Fed prepares for lift-off. Euro 5y5y forward inflation dropped below 1.60% yesterday and is only 10bp away from the 1.48% low than spurred the ECB into QE action in January", added Societe Generale.