Vii. Inflation Persistence in the Euro Area

Euro area inflation stubbornly above 2 per cent Headline inflation in the euro area has, on average, remained stubbornly above 2 per cent -the upper limit of the European Central Bank’s definition of medium-term price stability -for most of the period since mid-2000. This persistence may seem puzzling in the light of weakness in activity and is only partly explained by factors like oil and food prices, and exchange rates. Core inflation, which excludes some of these elements, and the service component of the index, a measure less sensitive to exchange rate developments, have both been rising since late 1999 (Figure VII.1, top panel). At the same time, the inflation rates across euro area economies have diverged (Figure VII.1, middle panel). The policy issues that arise concern both the appropriate rate of inflation that should be used to guide monetary policy decisions and whether structural reforms could enhance the responsiveness of inflation to weak economic activity.