The eurozone’s improving inflation outlook could leave the ECB behind the curve

Slowly but surely, the inflation outlook for the eurozone is improving. Headline inflation is normalising, but persistent core inflation is complicating things. While this remains the case, the European Central Bank will continue hiking interest rates – but for how long?

Inflation is moving in the right direction, but will core inflation remain stubborn?

Headline inflation has come down sharply and is widely expected to continue to fall over the months ahead. The decline in natural gas prices has been remarkable over recent months, and while it would be naïve to expect the energy crisis to be completely over, this will result in declining consumer prices for energy. The passthrough of market prices to the consumer is slower on the way down so far, which means that there's more to come in terms of a downward impact on inflation.

For food, the same holds true. Food inflation has been the largest contributor to headline inflation from December onwards, but recent developments have been encouraging. Food commodity prices have moderated substantially since last year already, but consumer prices are now also starting to see slowing increases. In April and May, month-on-month developments in food inflation improved significantly, causing the rate to trend down.

Historical relationships and post-pandemic shifts

As headline inflation looks set to slow down further – at least in the absence of any new energy price shocks – the question is how sticky core inflation will remain. There are several ways to explore the prospects for core inflation.

Let’s start with the historical relationships between headline and core inflation after supply shocks. Data for core inflation in the 1970s and 80s are not available for many countries – but the examples below for the US and Italy show that an energy shock did not lead to a prolonged period of elevated core inflation after headline inflation had already trended down. In fact, the peaks in headline inflation in the 70s and 80s saw peaks in core inflation only a few months after in the US and coincident peaks in Italy. We know that history hardly ever repeats, but it at least rhymes – and if this is the case, core inflation should soon reach its peak.

During previous supply-side shocks, core inflation did not remain elevated for much longer than headline inflation