A quick note to show that the Euro area inflation problem is much bigger than the ECB doves assume. We use the Italian data that ISTAT has released this morning. We will circulate a full update on EA HICP tomorrow. Bottom line: we see large upside risks around the Italian 10y yield.
The facts
The issue is much bigger than most assume. This morning, ISTAT released the final HICP reading for January. ISTAT release can be found here. Figure 1 shows the MoM (ar) of core HICP (seasonally adjusted in-house). We estimate that in January core HICP grew at the astonishing MoM annualized rate of 8.8%. Figure 2 shows additional metrics of core HICP for Italy. Please note that the 3m/3m (ar) has now reached 8%, and trending higher. Please, also note that the YoY has plenty of room to keep trending higher in the coming months. Translated: in our view, there is a clear underestimation of the size of the issue, especially by the doves. As a reminder, while headline HICP will most likely moderate in 2023, if the ECB does not disinflate core inflation, it will put the seeds for a replay of the 1970s. The evidence for Italy is now very, very challenging.
Figure 1. MoM at annual rate of core HICP, Italy – seasonally adjusted by UnderlyingInflation.com
Figure 2. Core HICP metrics, Italy
A technical note
3.2% core HICP inflation (average 2023) is the lowerbound at this point. The ISTAT note contains the following sentence (in Italian) “L’inflazione acquisita per il 2023 è pari a +5,2% per l’indice generale e a +3,2% per la componente di fondo” (please note that this sentence does not appear on the English page). The sentence refers to CPI but it is important also for HICP. The sentence can be translated as follows: “acquired inflation for 2023 is 5.2% for headline and 3.2% for core”. By “acquired inflation”, ISTAT means that if 2023 was ended in January, average inflation (that is, calculated the Eurostat way) would be 5.2% for headline and 3.2% for core. The point is that going forward “acquired inflation” can fall only if the 2023 level will be lower (that is, only if the MoM will be negative). It follows that the 3.2% for core inflation is a lower bound at this point because the MoM will certainly be positive and will push the 2023 average higher. Not only, but the 3.2% mentioned by ISTAT is in CPI space, while HICP is already running higher by about ½ percentage point. For this reason, the ECB staff forecast of 4.2% for core HICP in 2023 is really puzzling to us. Put it simply: how can the entire year turn out to be 4.2% for core HICP if in January “acquired inflation” in one of the largest countries is already close to that? Someone should send an email to Panetta and Lane and ask..
(For brevity, we do not show the results of the DG ECFIN business survey for January – available upon request. The takeaway is that the share of firms in the services sector that expect higher prices in the next 3 months has reached an all-time high.)
Upside risks around the 10y yield
We see large upside risks around the Italian 10y yield. Figure 3 shows headline HICP (YoY), core HICP (YoY) and the Italian 10y yield. As usual, markets have been rational and reacted only to core inflation. However, the 10y yield has gone sideways (with volatility) since September despite core HICP has been trending higher. As mentioned, we expect the YoY of core HICP in Italy to continue to trend higher in the coming months, possibly going above 8%. For this reason, we now see large upside risks around the Italian 10y yield.
The ECB staff and the Governing Council might remain in La-La land for a while. But at some point, the data will make them waking up. And the data are running at the incredible pace of 9% MoM (ar).
Figure 3. Headline, Core HICP inflation (YoY) and Italian 10y yield
