Dovish risk: The challenging mechanics of inflation normalization
The mechanics of inflation normalization are challenging, underlining the need
for slow policy normalisation. Pre-crisis, inflation was in line with the ECB target
on average because inflation rates were faster in the periphery than the core.
Periphery-led inflation reflected an unsustainable pattern of debt-fueled
domestic demand, large current account deficits and a higher exposure to
import prices.
Today, each of the Big4 is contributing to sub-target inflation. The
normalization of inflation requires either (a) a return to the pre-crisis pattern, (b)
a new regime where inflation accelerates in Germany and France or (c) inflation
to accelerate evenly in all member states. If nominal wage growth over the next
couple of years is in line with national central bank forecasts, the normalisation
of euro area inflation could potentially be led by France and Italy among the
Big4. However, when the external rebalancing constraint is applied, it may be
that only France is capable of generating faster inflation and only if it can bolster
its non-cost competitiveness.
EU Forecast
euf:ba18h:142/nws-01