ECB sees domestic demand offsetting stronger euro, for now

[FRANKFURT] The European Central Bank says robust domestic demand has helped prevent a stronger currency from weighing on euro-area inflation - so far.

In a section of its economic bulletin published Wednesday, the ECB noted that exchange-rate movements can play an important role in shaping the outlook for inflation, albeit with considerable delays and differences based on the economic situation. The report comes after the euro strengthened as much as 10 per cent against the US dollar in the last year before weakening in recent weeks.

The euro's past appreciation has been clearly visible in making consumer goods imported from outside the euro area cheaper, the ECB said. Prices of such goods declined 2 per cent in April from a year ago. They make up more than a tenth of final non-energy and non-food goods consumption.

While that's a drag on overall inflation, domestic producers seem to be offsetting the impact. They've remained resilient to downward pressure due to rising labor compensation and higher capacity utilisation giving companies more pricing power. Prices for non-energy industrial goods have also been stabilized by domestic forces, even though the ECB says these are most sensitive to movements in the exchange rate.

That's good news for the central bank, which has struggled to stimulate low inflation for years and has only recently admitted that it's making substantial progress toward its goal. Still, it warns that effects from the exchange rate might still weigh on inflation in the near future.

"Pass-through models suggest that the impacts are spread out over several quarters, so that the appreciation from mid-2017 might still be relevant for some quarters to come," the ECB said in the report. "Monitoring the impact of the past euro exchange rate appreciation on the inflation outlook is an ongoing exercise."

BLOOMBERG