Good News, Maybe
The April HICP report brought some good news. However, we invite to be extra careful before celebrating. Our models suggest that the distribution of price changes is finally showing some improvements. However, there is still no visible improvement in the estimated “common component” across items which remains solid. As previously communicated, we are extra careful in this moment because the filters are more sensitive/biased than usual in the last part of the sample. Nevertheless, today’s report brings some hope that in the next few months we might be getting some moderation (around 4%-5% ar MoM of core HICP).
As for monetary policy, the ECB staff and the Governing Council are so behind the curve that, in our estimates, even with some downward surprises, the projections should be revised up, forcing monetary policy to remain very hawkish and bringing the terminal rate around 4%.
Evidence from the distributions
The distribution: some good news? Taken at face value, this month we got good news from the percentiles (not shown) as they all moved down and below the levels of a couple of months ago. Also, a strong signal comes from the Kernel of price changes. Figure 1 shows that the distribution of price changes in the last three months is finally trying to send positive news, as well as the median of the distribution (Figure 2).
As we said over and over again, ultimately they only thing that matters is the distribution of price changes. Therefore, if anything, today brings some good news. Having said so, we remind that, unfortunately, the evidence in Figure 1 is not written in stone because next month the filters will re-estimate everything and recent history will look different (with risks sweked to the upside given that the NSA levels of core HICP does not show any improvement yet).
To sum up: the evidence is more benign that what we expected. However, given the circumstances, we take less signal than usual. Overall, the evidence in Figure 1 can be taken as an indication that some “moderation” (i.e. MoM readings around 4%-5% ar for core HICP) might be coming in the next few months. Needless to say, we remain far away from the pre-Covid distribution.
Figure 1. Kernel of HICP excluding food and energy items changes (%, a.r.)
Figure 2. Median HICP price increase
Evidence from our CI-C model
Our CI-C model estimates that net of Covid and idiosyncratic shocks, the common component across items in April was solid and in line with the previous months. Figure 3 shows the decomposition of the MoM of core HICP in the “common” component, the “idiosyncratic” component, and the “Covid” effect. The model estimates that in April the common component increased by 16bps, in line with the average of the previous 16 months or so. The Covid effect is estimated at 20bps, and the idiosyncratic shock is positive (9bps). As we did in previous months, we consider the “true” core rate net of the idiosyncratic shock. Therefore, a rough estimate put the MoM of core HICP at around 4.3% ar in April (which again is where we expect core HICP to be in the next few months).
Figure 3. Contributions to MoM changes of HICP excluding food and energy items
Note: the Figure shows the decomposition of the MoM percent changes of HICP prices excluding food and energy items. The contributions are estimated using our CI-C model, a 2-stage OLS-LASSO regression model. The “Covid” effect is identified with price variations outside the 10th-90th percentiles of each item pre-Covid price change distribution.
Figure 4. Estimated “Common” component: YoY, 3m/3m a.r. and 6m/6m a.r.
Note: the Figure shows the 3m/3m at annual rate (green line), the 6m/6m at annual rate (red line), and the YoY (blue line) of the “common component” estimated using our CI-C model.
Implications for the medium-term forecast of core HICP
The medium-term forecast of core HICP is little changed as the final release was close to the flash estimate. The forecast is at 5.3% (Q4/Q4) in 2023 (average of four quarters at 5.4%), 3.7% in 2024, and 3.5% in 2025. The confidence bands (calculated from the estimated parameters distributions) suggest that the risks are skewed to the upside.
Note: the confidence intervals (C.I.) are calculated using the estimated parameters distributions.
First quarter of forecast: 2023:Q3.
Implications for the ECB staff and the Governing Council
Nothing has changed for the Governing Council today. As we pointed out in other notes (see for instance here and here) the Governing Council is likely to remain very hawkish in the near-term because we expect the ECB staff forecast (of core HICP) to be revised up, and significantly so, in June. Is moderation coming in core HICP going forward? To the extent that part of the inflationary process was driven by “supply-side” factors, then one should expect softer readings going forward. But the overall picture remains the same: a large portion of the process is demand-driven and requires monetary actions. Not only, but as mentioned, interpreting the data right now is particularly challenging because of seasonality issues. In this environment, in our estimates and view, it is wise to update the priors only marginally because the evidence is likely to be revised next month. Therefore, for the time being we continue to expect the terminal rate at (at least) 4%.