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Eurozone inflation rises to 5-month high as energy drag recedes

Inflation across the 19-nation euro area rose to a 5-month high in June as the drop in energy prices moderated. According to Eurostat’s flash estimate, annual CPI increased to 0.1% in June from -0.1% in May. It was the first positive reading since January and was above consensus forecasts of 0%.

Core CPI, which excludes energy and unprocessed food items, was unchanged at 0.8% year-on-year, in line with analysts’ expectations.

The pick-up in the headline rate was mainly due to a smaller decline in energy prices. The recent rebound in crude oil prices appears to be making its way into the CPI calculations as energy prices fell by 6.5% annually in June – the smallest decrease since January. Other components of CPI were steady with little or no change from the previous month.

The euro firmed after the data to hit an intra-day high of 1.1154 dollars but later fell back towards 1.1110 dollars. The single currency has recovered from its low of 1.0910 dollars immediately after the UK’s EU referendum outcome but remains below pre-Brexit levels of 1.13 dollars.

The higher inflation rate will be welcome by the European Central Bank, which has embarked on a massive asset purchase program in order to boost prices across the Eurozone. However, with core inflation showing little sign of accelerating just yet, the ECB will likely wait for more concrete signs that prices are on an uptrend such as looking at measures of inflation expectations, which remain near record lows.

Another factor that the ECB will now have to weigh in its outlook is Britain’s decision to leave the EU. The shock referendum result rocked financial markets in the immediate aftermath of the vote, threatening to derail a fragile global economic recovery. ECB President Mario Draghi warned on Tuesday that Eurozone growth could be hit by up to 0.5% over the next three years from the Brexit fallout.

EU leaders have called for an orderly exit of the UK from the organization but a prolonged period of negotiations and/or an unfavourable terms of agreement for Britain will likely dampen business sentiment in the EU as well as in the UK. For the moment though, the ECB is expected to wait-and-see to assess the potential damage to the Eurozone economy from the Brexit vote before considering on embarking on a new round of monetary easing. What is more certain however, is that the ECB will likely stay in easing mode for far longer than previously anticipated as a result of the negative impact from the recent events which have yet to fully unfold.

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