Inflation in Europe: explanatory drivers and perspectives

Summary

The bulk of the prediction error for inflation in 2014, made a year earlier, is explained by oil prices. The impact of 10% lower oil prices on inflation is between 0.2pp and 0.3pp, while the effect on core inflation is less than 0.1pp. Our new scenario of oil around USD65 in 2015 and USD75 in 2016 has led us to revise downward our inflation expectations, with lows of between -0.6% and -0.7% YoY in February and March. The risks are both upwards (through higher depreciation of the euro) and especially downwards (for oil prices stuck at current levels or even lower), and the de-anchoring of inflation expectations. The role of the ECB in raising levels of inflation and balancing the downside risks is key

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