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Euro zone inflation dips as 'taper' talk builds ahead of ECB meeting

Tourists and pedestrians fill an aisle between food stalls inside Boqueria market in Barcelona, Spain.
Pau Barrena | Bloomberg | Getty Images
Tourists and pedestrians fill an aisle between food stalls inside Boqueria market in Barcelona, Spain.

Inflation data in the 19-member euro area dropped to 1.4 percent (year-on-year) in May, from 1.9 percent in April, according to fresh figures Wednesday from the European statistics office.

The decrease was mainly influenced by energy prices. Despite being the most important component driving up inflation, energy fell to 4.6 percent from 7.6 percent in April.

Nonetheless for the past few readings, headline inflation has been nearing close to, but still below, the 2 percent target of the European Central Bank (ECB).

The continuous surge in inflation and positive economic data across the bloc keep adding pressure on the ECB to start reducing its monetary stimulus.

Tapering talks could start next week

Four unnamed ECB officials told Reuters on Tuesday that the central bank is getting ready to soften its stance on monetary easing next week at a Governing Council meeting.

The meeting on June 8 is the first since the outcome of the French election and will provide an economic update to members. The reduced political uncertainty in the euro zone coupled with stronger inflation and solid economic figures could kick off the discussion on how and when the central bank should "taper".

"In the grand scheme of things, this report merely shows that euro zone inflation pressures returned to 'trend' in May following an unsustainable jump in April," Claus Vistesen, chief euro zone economist at Pantheon Macroeconomics, said in an email.

"Draghi likely will reiterate that the ECB sees no 'sustained upturn in underlying inflation' when the ECB meets next month. Core inflation is a long-lagging indicator in the euro zone, though, and we think it will move higher soon," he added.

Next week's potential talk on "tapering" should therefore be a brief one. The surge in inflation has been mainly driven by energy prices and the ECB is more generally concerned that it is not on a sufficient enough path of sustainability. ECB President Mario Draghi told lawmakers on Monday that despite the positive trend across the bloc, overall extraordinary policy needs to stay.

"We remain firmly convinced that an extraordinary amount of monetary policy support, including through our forward guidance, is still necessary for the present level of underutilized resources to be re-absorbed and for inflation to return to and durably stabilize around levels close to 2 percent within a meaningful medium-term horizon," Draghi said.

Removal of 'downside risks'?

Achilleas Chrysostomou, economist at Standard Chartered, said in a research note on Wednesday, that the European Central Bank is "to begin preparing the market for the end of its quantitative easing program by removing the reference to 'downside risks' to growth at its 8 June meeting."

He added that he sees the ECB tapering next year but the first rate hikes should not take place before 2019.

"Comparing the ECB's balance sheet to the Fed's, significant divergence seems set to continue in the next 12 months," Chrysostomou said.

"We expect the ECB to continue net asset purchases until around the third quarter of 2018, while the Fed will likely begin reducing its stock of quantitative easing assets early in 2018 …These opposite moves mean that the ECB's balance sheet could be around 20 percent larger than the Fed's by around end-2018, assuming constant FX rates," he noted.

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