Economic news from the eurozone is not good and the region appears to be teetering on the edge of a recession. But the ECB has maintained interest rates at 4% because annual headline inflation, at 2.9%, and annual core inflation, at 3.4%, were still much above the inflation objective of 2% in December.
Annual inflation can be thought of as the average monthly inflation rate over the past year. It therefore lags current inflation pressures by several months and can be high because prices were rising rapidly eight or ten months ago. In a situation in which inflation pressures are changing rapidly, that lag can lead policy makers to be too slow to adjust policy.
The chart below shows headline and core inflation, measured over 12, 6 and 3 months (the latter two annualised). Measured over 6 months, headline and core inflation are both 2.1%. Measured over 3 months, headline inflation is negative and core inflation is 1.2%.
On this basis price stability thus seems to have been achieved. In our view, the ECB could be seen as running policy too tight and should cut interest rates, possibly faster and deeper than markets expect.
