Euro area inflation is easing, but the drivers are getting noisier
At Indicio, we spend a lot of time separating a calm headline from a noisy reality.
Euro area inflation has dipped below the ECB’s 2% target, with the latest reporting pointing to 1.7% year on year for January 2026. (ft.com) That is the kind of number that makes markets exhale. But when we look under the hood, the forces that typically drive inflation are getting more volatile again.
Two examples stand out right now:
- European gas storage has fallen to its lowest seasonal level since 2022 after stronger winter drawdowns, and that has helped push prices higher. (ft.com)
- Oil remains highly sensitive to geopolitics, and recent market narratives have again focused on potential supply disruptions linked to tensions in the Middle East. (theguardian.com)
In a mixed macro regime like this, inflation forecasting usually improves when you move beyond a single inflation time series and model the underlying drivers directly.
Our forecasting setup
We modelled Euro Area HICP Total, change year on year, using Eurostat’s harmonised inflation framework. (ec.europa.eu)
We compared two approaches:
- Univariate model RMSE: 0.2845
- Multivariate model RMSE: 0.22708
That is a 20.18% reduction in forecasting error for the multivariate setup versus the univariate baseline.
Why this matters: when inflation is being tugged by energy, exchange rates, shipping, and labour dynamics at the same time, a univariate model can be slow to spot turning points because it only learns from the inflation series itself.
Our forecast horizon and what we see next
Our forecast horizon is 5 months. Using a multivariate inflation forecasting model, we expect Euro Area HICP inflation to increase through late spring, reaching 1,9% year on year by June 2026. This is not a return to the extreme inflation of 2022. Instead, it signals a modest re acceleration in Eurozone inflation, driven by renewed energy price pressures and higher imported input costs, while demand indicators remain mixed.
In inflation forecasting, a univariate model often works well when inflation is mainly trend driven and major shocks are limited. However, the current inflation environment is increasingly shaped by changing drivers, which is where a multivariate model typically performs better. In this case, the multivariate approach delivers about a 20% reduction in RMSE compared with the univariate baseline, indicating that the added economic indicators improve forecast accuracy by adding real signal rather than unnecessary complexity.
What we fed into the multivariate model
Our indicator set is designed to cover the main channels that move HICP.
Labour market and demand
- Growth of employment (Conference Board TED)
- Unemployment rate estimate (Handelsbanken)
- Employment expectations indicator, balance (DG ECFIN surveys)
- Retail trade confidence indicator (DG ECFIN business surveys)
Activity and pipeline inflation
- Producer price index, domestic sales, total industry excluding construction (ECB, Euro Area 20)
- ECB projections database series on price and cost developments, including wholesale related measures
Energy and commodities
- Brent crude oil 1 month forward (ECB financial market provider)
- Natural gas index (HWWI commodity indices)
- Food index (HWWI commodity indices)
- Commodity terms of trade index (Citi leading indicators)
Trade, logistics, and external prices
- Import totals and external trade conversion factors (UN Trade Statistics)
- Baltic Dry Index (global shipping cost proxy)
Exchange rates and pass through
- EUR per USD (Macrobond FX spot rate)
- Nominal effective exchange rate, broad index (Bruegel NEER)
Growth expectations
- Real GDP growth forecast (Nykredit)
Taken together, this gives us a coherent map of inflation pressures: pipeline costs (PPI and wholesale), energy (oil and gas), imported inflation (FX and trade), demand and labour tightness (employment, unemployment, confidence), plus a practical supply chain pressure gauge via shipping.
Why this model fits what’s happening right now
Energy is the swing factor again, especially gas
Europe’s storage situation has tightened meaningfully compared with recent winters, and that keeps energy inflation risks asymmetric during cold spells and late winter restocking. (ft.com) Even if headline HICP is cooling, energy can change the month to month story fast.
Why our approach helps: we include natural gas and oil forward pricing, so the model can react earlier than HICP only approaches when energy reprices.
Supply chain and shipping costs are back on the radar
Recent reporting has flagged renewed concern about shipping costs and broader supply chain instability, which can feed into goods inflation with lags. (theguardian.com) Baltic Dry has also moved notably over the past year, reinforcing that freight conditions can change quickly. (tradingeconomics.com)
Why our approach helps: Baltic Dry acts as a freight proxy, while trade conversion factors and FX strengthen the imported inflation channel.
Methodology changes can create apparent jumps in the data
Eurostat has noted methodological changes taking effect in early February 2026, including moving to ECOICOP version 2 and updating the index reference period to 2025=100. (ec.europa.eu) The ECB has also highlighted that major HICP methodological changes are coming into effect on the same date. (ecb.europa.eu)
Why it matters for forecasting: even when underlying inflation is stable, definitional changes can affect measured series behaviour. Driver based models help reduce the risk of overreacting to a statistical break.
Scenarios we are watching for the next few prints
If energy stays elevated
Tighter gas fundamentals and geopolitics can raise the odds of a headline inflation re acceleration, which aligns with our model’s steady move higher into June 2026. (ft.com)
If the euro strengthens
A stronger effective exchange rate usually dampens imported inflation, and could pull the June outcome below our 1,9% path. Our EURUSD and NEER inputs are designed to capture that pass through as it builds.
If shipping normalises
Any easing in freight rates tends to reduce goods inflation pressure with a lag. Baltic Dry and trade indicators are there to detect those shifts earlier than HICP alone. (theguardian.com)
Closing thought
Headlines can suggest the inflation problem is solved, while the inputs quietly get more unstable. Our results show that incorporating energy, FX, shipping, trade, and labour indicators materially improves forecast accuracy for Euro Area HICP in this regime.
Over the next five months, we expect inflation to drift higher and reach 1,9% by June 2026. We will keep updating the signal mix as new data arrives, especially on energy pricing, freight conditions, and exchange rate pass through.
