The lowest euro area CPI print in four years has not spurred investors to reconsider the outlook for this week’s ECB meeting.  Most recognize the ECB is likely to shrug off today’s preliminary report.
It is not clean, in the sense of the base effect of lower oil prices and that distortions caused by Easter (last year Good Friday was on March 29, so holidays were booked in March, which exaggerate the drop as such booking will be concentrated in April this year).  Some economists are forecasting that this will be the trough in euro area CPI.
The Wall Street Journal asks, “Is Abenomics pushing Europe toward deflation?” The reporter answers in the affirmative: “…Deflation pressures in the euro zone are also being driven by the monetary policy elsewhere, not least in Japan.”
This sounds reasonable.   The yen has depreciated by about 29% against the euro since the start of November 2012, when it become clear that Abe would likely be given a second try as Japan’s Prime Minister.  To attribute much of the disinflationary (if not deflation) headwinds in Europe to Japan is an exaggeration.
First, the bulk of the yen’s weakness occurred before the end of H1 2013. Since then the yen has depreciated about 9% against the euro. Headline euro area CPI was 1.6% in June and July 2013. It now stands at just less than a third of that.  If with unpredictable lags and lead times, there does not look to be much of a smoking gun here.
Second, and more importantly, the euro area does not trade that much with Japan, making the impact of the currency fluctuations less significant. According to the ECB, Japan’s exports account for about 3.2% of the euro area imports.   On a trade-weighed basis, looking at the euro area’s largest trading partners, the yen’s weight is about 7%.
Third, when the ECB hiked rates with inflation above 4.0%, the euro was trading near JPY170.  This month it has averaged about JPY141.50. This is to suggest, that knowing where the euro-yen cross is trading does not allow one to forecast euro area CPI.
