European inflation slowed further in August

Despite the rebound in energy prices in August, inflationary pressures continued to ease in the eurozone and in Switzerland. In the eurozone, headline inflation remained at 5.3% year-on-year (YoY), the same rate as core inflation, which fell further from the 5.7% peak reached in March (see Chart 1a). While both measures are well above the ECB's 2% target, they are down from their peaks.

Chart 1a. Eurozone inflation rates (YoY)

Chart 1b. HICP components (3-month avg annualised)

Source: ECB, LSE Data & Analytics and EFGAM calculations. Data as of 01 September 2023.

Four factors justify some optimism that eurozone inflation is finally returning to 2%.

First, the base effect is favourable due to the spikes in energy and food prices at the end of 2022 and the first months of 2023 that will fall out of the calculations in the months ahead. Second, seasonally adjusted data show a slowdown in recent monthly Harmonised Index of Consumer Prices (HICP) changes.¹ Prices of food, core goods and services have all moderated compared to late 2022 and early 2023 (see Chart 1b). Third, the euro has appreciated in nominal, trade-weighted exchange terms by 6% from the low reached in August 2022 and this will contain imported inflation in contrast with the last couple of years.

Fourth and arguably most importantly, much of the monetary policy tightening has only recently started to pass through the pipeline. It is therefore reasonable to expect that the interest rate increases that began in July 2022 will increasingly dampen inflation in the coming months even in the absence of further policy tightening by the ECB.

In Switzerland, August headline inflation remained at 1.6% YoY while core inflation fell to 1.5% YoY from 1.7% in July (see Chart 2a). The moderation in core prices is particularly significant considering that the August monthly increase in rents, which accounts for over a fifth of the core CPI basket, added 0.1% to YoY core inflation.

Chart 2a. Swiss inflation rates (YoY)

Chart 2b. CPI components (3-month avg annualised)

Source: KOF, LSE Data & Analytics and EFGAM calculations. Data as of 01 September 2023.

Furthermore, according to KOF data, the seasonally adjusted price index has risen on average by only 0.1% month-on-month over the past three months and core CPI is unchanged over the same period. Core inflation has moderated for some time: if the trend of the last six months is maintained, it will fall to 0.7% YoY in 2024 and one could conclude that price stability has already been restored in Switzerland.

The moderation of Swiss core inflation is broad based (see Chart 2b). The prices of core goods, excluding food and energy, have been falling since the end of 2022 and services prices have barely risen over the past six months.

In conclusion, August consumer prices in the eurozone and in Switzerland showed encouraging signs of moderation. In the short-term, this reduces the need to raise interest rates further, also considering that the impact of past interest rate increases has not yet been fully felt.

However, as annual inflation remains above the ECB’s and SNB’s targets, it is reasonable to expect both central banks to maintain a hawkish rhetoric that does not rule out further monetary policy tightening if needed.

¹ Using statistical techniques to remove the effects of seasonality, defined as systematic calendar-related variation in the data, makes it possible to compare data of consecutive time periods and timely detect changes in the underlying dynamics of an economic process.