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Eurozone: Unemployment continues to decline, but price pressures missing - ING

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Apr 6, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    Bert Colijn, Senior Economist at ING, suggests that Eurozone’s inflation last week, turned out to have remained in negative territory at -0.1% in March, while the unemployment rate showed another decline in February.

    Key Quotes

    “This marked the 13th month of consecutive declines in the number of unemployed, while prices are still declining. As people return to employment, price pressures usually emerge through improved spending. This relationship is called the Phillips curve, which now seems to behave less accurately.

    Debate about the validity of the Phillips curve has been going on for decades, but while the Eurozone Phillips curve has worked quite well over the years, it now seems that there is a breakdown of the relationship. The unemployment rate has come down over the past years, but inflation remains negative. This is of course mostly because of the exogenous shock in oil prices, but even core inflation has been stagnant since mid-2015. With an improving labour market, should price growth not be moving?

    While the recent behavior of the indicators suggests that there has been a breakdown in the relationship, it seems that that might not actually be the case. The relationship is strong and the behavior in 2015 has not been unusual. This is because the Phillips curve for the Eurozone is quite shallow. For every reduction of 10 basis points in the unemployment rate, there is a change of just 3 basis points in core inflation.

    Since July last year, this is exactly what has happened; the unemployment rate has come down from 10.8% to 10.3%. This should have resulted in a core inflation rate of 1.1%, but we currently see a rate of 1% for the March number. Given all the other factors that can influence such a monthly number, this does not give reason to assume that the Phillips curve has lost its relevance in the current economic environment.

    The flat Phillips curve does bode concern for the recovery of inflation. It means that unemployment has to be well below 9 percent for core inflation to return to the ECB target of “just below 2%”. Even at the current pace of 0.9% declines in the unemployment rate per year, this means that it will be a while before the labour market starts to give significant price pressures in the Eurozone.”
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