Calendar issues boosted July eurozone inflation

The cut in the VAT rate by three percentage points in Germany suggested that eurozone inflation would fall in July. Instead, it rose to 0.4% year-on-year (y/y) from 0.3% y/y in June (see Chart 1). Core inflation, net of volatile food and energy components, rose more sharply by 0.4 percentage points to 1.2% y/y. Although still far from the ECB's objective of inflation "below, but close to 2%", the July core inflation rate is relatively high compared to recent years.

Chart 1. Eurozone headline and core inflation (y/y)
 

Source: Eurostat, Refinitiv and EFGAM calculations.

It is natural to ask whether this marks the start of a trend driven by the higher costs necessary to ensure customers’ safety and the restrictions imposed on the supply of some services. Such cost-push inflation, in which companies raise prices to defend their profitability, would complicate the economic recovery at a time when final demand remains fragile.

Fortunately, the analysis of July inflation data suggests that the increase is temporary, driven by the delay of summer sales of clothing and footwear. Due to the lockdown, retail stores reopened to the public only in June and with significant constraints on operations. In order to limit the negative impact on the sector, governments delayed the start of summer sales by a few weeks. In France, sales began on 15th July instead of 24th June as planned before the pandemic. In Italy, sales have been postponed to 1st August from the usual start at the beginning of July. Therefore, the reported drop in clothing and footwear prices in July was much less pronounced than usual.

Chart 2. Clothing and footwear inflation (y/y)
 

Source: Eurostat, Refinitiv and EFGAM calculations.

The increase of clothing and footwear price inflation was pronounced in France, Italy and Belgium, and it was meaningful in most other eurozone countries (see Chart 2). The exception was Germany where clothing and footwear inflation fell to -1.5%, largely reflecting the cut in the VAT rate. For the eurozone as a whole, the deviation from the normal seasonality of summer sales caused inflation in the sector to soar to 6.3% y/y in July from -0.9% y/y in June (see Chart 3).

Chart 3. Core inflation and clothing and footwear inflation (y/y)
 

Source: Eurostat, Refinitiv and EFGAM calculations.

The weight of clothing and footwear is 5.9% in the headline CPI basket and 8.3% in the core CPI basket. Thus, between June and July this relatively small sector alone added 0.43% to headline inflation and 0.60% to core inflation. Absent this shock, headline inflation would have fallen to -0.1% y/y, the lowest since spring 2016, and core inflation to 0.6% y/y, a new all-time low.

The sudden surge in clothing and footwear price inflation will subside in August. Core inflation in the eurozone will return to low levels, consistent with the severe recession that hit the global economy in 2020. Overall, higher costs incurred by companies to cope with the Covid19 pandemic has not yet triggered higher inflation.