Not So Easy to Disinflate..
The August HICP report confirms that the fight against inflation is not so easy. Our models all point to the same direction now: net of noise and idiosyncratic shocks, core prices are growing at an annual rate of about 3-3½%. We do expect some moderation going forward but the point remains the same: it is very hard to see core HICP growing at 2% in the medium-term without additional help from the labor market.
The next HICP can be crucial. In NSA space, the level of core HICP can cross the 2022 path and finally suggest some moderation (should that not happen, a hike in Q4 is likely in our view and estimates). Given what happened so far, at this point we want to see some real progress and we want to see the models to revise down their forecast significantly before changing our view. If anything, we prefer to get a downward surprise in September. The burden of the proof remains on the fast disinflation camp.
Evidence from the distributions
The distribution: consolidation but the road to 2% remains long. Figure 1 shows the distribution of price changes in recent months. The good news is that in the last 3 months the distribution has shifted to the left compared to 6-9 months ago, and the median (Figure 2) has dropped notably compared to a year ago. The reasons for being careful is that (i) the distributions are calculated on seasonally-adjusted data (therefore are sensitive to possible residual seasonality), and (ii) the distribution reflects the disinflation in core goods. Not only but the median has ticked up in the last two months and remains well above pre-Covid levels and the 2% ECB target.
We are far from declaring victory. Disinflating requires time and a significant moderation of core services which could/should come with a help from the labor market.
Figure 1. Kernel of HICP excluding food and energy items changes (%, a.r.)
Figure 2. Median of HICP excluding food and energy items prices 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 August was 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 August the common component increased by 16bps, in line with the average of the previous months. The Covid effect is estimated at 11bps, and the idiosyncratic shock is positive (10bps). As we did in previous months, we consider as “true” core the one netting out the idiosyncratic part. Therefore, a rough estimate put the MoM (saar) of “true” core HICP at around 3.3% in August, roughly stable compared to the previous three months. In this moment, the signals from the distributions, the CI-C model, and the “main” Phillips curve model (see below), they all point to a “true” core HICP inflation a bit above 3% (which is the level we can expect the MoM saar to print going forward).
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
Medium-term model-based forecast is a touch lower. Today’s data imply only cosmetic revisions to the medium-term model-based forecast. The forecast is at 5.0% (Q4/Q4) in 2023 (average of four quarters at 5.3%), 3.3% in 2024, 3.1% in 2025, and 3.05% in 2026. The confidence bands (calculated from the estimated parameters distributions) suggest that the risks are still skewed to the upside.
Figure 5. Model-based medium-term forecast of core HICP (YoY)
Note: the confidence intervals (C.I.) are calculated using the estimated parameters distributions.
First quarter of forecast: 2023:Q4.
The NSA issue and a comparison with the ECB/NCBs staff forecast
The NSA level is not cooperating yet. Figure 6 shows the evolution of the unchained NSA core HICP (see our notes here and here about “unchained HICP”). So far, the cumulative NSA unchained inflation in 2023 is marginally higher than last year. We described it as the “plateau“: inflation is neither accelerating, nor decelerating in NSA space. This is why we are extra careful right now. The assumption (and hope for the continent) is that the level will cross the 2022 path soon (in September?).
Figure 6. Acquired unchained core HICP inflation
Note: the Figure shows the cumulative (“acquired”) inflation in each year, normalized at 1 on new years’ eve. The chart refers to core HICP, NSA. This procedure eliminated the “chain linking” mechanism of the HICP and results in the “unchained” index. For technical details, see our notes here and here.
Risks around the ECB/NCBs forecasts are to the upside. Table 1 shows a comparison between our (updated) forecast and the new ECB/NCBs staff forecast. As discussed in previous updates, the 2023 ECB/NCBs staff forecast for core HICP is now close to our own. 2023 acquired inflation for core HICP is 4.9%/5.0%. Therefore, the risks around the ECB/NCBs staff forecast remain skewed to the upside. Not only, but (conditional on our 2023 forecast) the 2023 carryover effect in core HICP space for 2024 is 2.1% which means that the 2.9% of the ECB/NCBs staff forecast for 2024 is at risk of being revised up again, unless we have a significant slowdown.
(For a technical note on the concepts of “acquired inflation” and “carryover effect” see here and here).
Table 1. Comparison of forecasts
Note: the “UnderlyingInflation” forecast refers to the “main” model in Figure 5 (judgmentally adjusted).