Official figures yesterday from the European Union's statistics agency, Eurostat, showed that consumer prices across the single currency bloc were up 0.3 percent in May from the year before. That's up from the flat reading in April and is the first positive reading since November. It's also above market expectations for a more modest 0.2 percent rise and suggests the eurozone is past its bout of falling prices, which can become a long-term threat to growth.
The euro rallied strongly in the wake of the figures, trading 1.2 percent higher at $1.1050. Many traders think the uptick will ease the pressure on the European Central Bank to extend its current monetary stimulus beyond its planned end date of September 2016. Eurozone consumer prices started falling in December, partly because of a sharp drop in global oil prices. The anemic state of the eurozone economy as well as high unemployment also kept a lid on inflation by subduing wages.
However, over the past couple of months, oil prices have started edging higher while underlying inflation pressures across the eurozone appear to be intensifying as the eurozone economy shows signs of improvement. That's evident in the fact the core inflation rate which strips out volatile items such as food, energy, tobacco and alcohol was up 0.9 percent in the year to May, above April's 0.6 percent rate.
Policymakers at the European Central Bank will welcome Tuesday's inflation news as they gather in Frankfurt, Germany, for their latest policy meeting. However, they're unlikely to get carried away as the headline inflation rate is still way short of the target of just below 2 percent. In March, the ECB launched a 1.1 trillion euro ($1.2 trillion) monetary stimulus program that aims to stoke inflation and growth by injecting newly created money in the economy. A by-product of the policy was to push the euro down, which raises the price of imports and helps shore up inflation.
The ECB's concerns centered on the possibility that prices might fall consistently over time. Such a longer-term fall in prices, called deflation, encourages people to put off spending and can prove difficult to reverse because it requires altering people's expectations. It can lead to years of economic stagnation, as in Japan over the past two decades, or even something more severe, such as the Great Depression of the 1930s.
Though some of the concerns of the ECB's policymaking governing council may have been eased by the return to inflation, the prevailing view in markets is that the bank will persevere with its stimulus until the planned end-date. Any suggestion it could halt it sooner could prompt the euro to appreciate.
"While today's outturn may provide further breathing room for the governing council by reducing the risk of a more pernicious deflationary environment taking root it is far from sufficient to precipitate a change of course," said Timo del Carpio, European economist at RBC Capital Markets.