Does monthly eurozone inflation suggest price stability has been achieved?

When commenting on inflation, economists typically look at changes in prices over a year. That is helpful because it removes the large seasonal fluctuations that affect consumer prices. But it can also be misleading when inflation pressures are changing. The September release of the Harmonized Index of Consumer Prices (HICP) in the eurozone is a case in point.

For inflation to settle perfectly at the ECB’s 2% target for annual inflation, the monthly increase in prices would need to average 0.17% over twelve months. It is therefore interesting that the monthly inflation rate shows a change in the behaviour of price pressures since March (see Chart 1).

Chart 1. Eurozone HICP inflation (% change, month-on-month)

Source: Eurostat, ECB and EFG calculations. Data as at 04 October 2024

Since then, the monthly inflation rate of the seasonally adjusted HICP has averaged 0.15%, corresponding to an annual inflation rate of just 1.7%. In this period there was only one month that was an outlier, July, when inflation reached 0.3%. That important fact is missed if one only looks at annual inflation.

It is worth noting that one reason behind the changed behaviour of monthly inflation is the sharp decline in energy prices.¹ That decline is likely to be transmitted to other prices although it is possible that it is not sustained. Nonetheless, the behavior of monthly inflation over the past seven months suggests that that the eurozone has returned to price stability. If so, the incoming monthly inflation rates will average about 0.17% henceforth, leading annual inflation to stabilise at around 2% over the coming twelve months. 

To see this more clearly, recall that the monthly change in the annual inflation rate is equal to the incoming monthly inflation rate minus the monthly inflation rate twelve months ago that drops out of the calculation – this is the so called ”base effect” that is often commented on in the press.²

Since monthly inflation rates of the last year are known, so is the base effect over the coming year. It is therefore interesting to calculate what the annual inflation rate would be if the incoming monthly inflation rates were exactly 0.17%, so that all fluctuations in inflation came from the base effect. Such an exercise is illustrated in Chart 2.

Chart 2. Eurozone HICP inflation forecast assuming monthly inflation of 0.17%

Source: Eurostat and EFG calculations. Data at 04 October 2024

These calculations suggest that annual inflation will rise in the coming months because of base effects (that is, because of the behaviour of inflation last year), then decline sharply in early 2025, and remain below 2% before settling at 2% in September 2025. 

In practice, of course, monthly inflation will not equal exactly 0.17% month after month. Some fluctuations are inevitable. But if the incoming data continue to evolve similarly to the last seven months, then annual inflation would behave broadly as suggested above. 

Of course, the Governing Council will want to be sure that inflation has been overcome and will look keenly at the monthly data. One month in which inflation is unexpectedly high may lead the ECB to hold interest rates constant to make sure that it is not returning in a lasting way.

Nevertheless, while annual inflation may rise above 2% in the coming months, by next year it will likely have returned to the price stability level. As such, rate cuts by the ECB should be expected to continue.

¹ Eurozone energy inflation has averaged -0.74% month-on-month since March.
² This assumes that continuously compounded rates of inflation are used. If discretely compounded rates are used, a similar, but less intuitive relationship applies.