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Eurozone inflation spikes to highest in over 3 years

Posted January 4

A child laughs as she tries to catch soap bubbles created by a street artist, in Lisbon's Comercio square, Tuesday, Jan. 3 2017. (AP Photo/Armando Franca)

— Europe appears to have seen off the deflation bugbear that has stalked it for the past couple of years.

Consumer prices across the 19 countries that use the euro grew in December at their fastest rate since Sept. 2013, official figures showed Wednesday.

A surge in oil prices contributed most to the near-doubling in the annual inflation rate to 1.1 percent from the previous month's 0.6 percent.

Though higher inflation can eat into consumer spending, it can also help push up wages and stimulate economic activity in a region that has largely stagnated.

As such, the figures are likely to provide some relief to policymakers at the European Central Bank who have resorted to a raft of stimulus programs to get inflation back toward their target of just below 2 percent, considered most suitable for a healthy economy.

With the inflation rate still short of that target, the central bank is unlikely to give up on stimulus anytime soon.

Though the ECB can argue that its policies, which have included cutting interest rates and injecting billions into the financial system, have shored up the economy, the main contributor to the December spike in inflation was out of its control: energy prices.

Eurostat, the European Union's statistics agency, said energy costs were up 2.5 percent in the year to December compared with a 1.1 percent drop in November. In December, the price of crude oil rose above $50 a barrel — from below $30 a year earlier — after the OPEC oil cartel and other nations agreed to cut output levels.

When energy costs are excluded, inflation remains muted. The core rate, which strips out the volatile items of alcohol, energy, food and tobacco, rose to only 0.9 percent from the previous month's 0.8 percent. That suggests that high unemployment in many parts of the eurozone following the region's debt crisis continue to weigh on wage demands and consumption.

"Despite headline inflation returning to an upward trend we expect that the ECB's preference will be to maintain the policy course ... and 'look through' energy-influenced price developments in coming months," said Cathal Kennedy, European economist at RBC Capital Markets.

In the near-term, higher headline inflation could weigh on economic activity if wages don't keep up, as people's income won't go as far.

However, a steady level of inflation is considered good for an economy as it can drive up wages and promote innovation and investment by firms. It can also reduce debt levels for firms and countries in real terms.

That's certainly a better prospect than prices falling over a sustained period, a phenomenon known as deflation that has haunted Europe in the past few years.

Lower prices may sound good and have in fact been a boon to European consumers recently as they were due to the slide in oil prices — money saved filling up a car or on home heating could be spent elsewhere.

The problem arises when a fall in prices endures. That can choke the life out of an economy if consumers put off purchases in the hope of future bargains. It can erode profits and make governments' debts appear greater. Deflation has proven difficult to reverse, as evidenced by the case of Japan over the past couple of decades.

Ben May, lead eurozone economist at Oxford Economics, conceded that higher inflation could weigh on eurozone economic activity in coming months, while noting that it may "trigger some positive developments" such as higher wages in economies like Germany where unemployment is low.

"We think that the eurozone economy is now in a strong enough position to weather this shock," he said. "Indeed, the region may now be in a position where a period of moderate inflation is more desirable that a further sustained bout of 'noflation'."

The view in the currency markets was broadly positive and the euro recouped some of its recent losses, which had seen it fall to 14-year lows against the dollar. Europe's single currency was up 0.7 percent at $1.0477.

A separate survey Wednesday provided evidence that the eurozone economy gained momentum at the end of 2016.

According to research firm IHS Markit, eurozone business activity grew in December at its fastest pace since May 2011. The company's composite purchasing managers' index — a broad gauge of business activity across the manufacturing and services sectors — rose to 54.4 points in December from 53.9 the previous month. Anything above 50 indicates growth.

It said December's level points to quarterly economic growth of 0.4 percent — better than the eurozone performed for most of 2016 but modest compared with the United States.

IHS Markit's chief business economist, Chris Williamson, said it's too early to say whether the improvement represents the "much-needed springboard" because political uncertainty looms. Key events this year include elections in many European countries, including France and Germany, and the start of Britain's discussions to leave the EU.

"The concern is that domestic demand is likely to remain subdued over the course of 2017 as political uncertainty dominates, resulting in another year of disappointing growth across the region as a whole," Williamson said.

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