The December HICP report came in as expected and does not provide clarity on whether or when inflation will reach and remain at the target level. The overall picture remains largely unchanged. Today’s report indicates a distribution that is less dispersed around the target but still features a strong common component. Based on this, we continue to anticipate near-term MoM (saar) readings in the 2.0–2.5% range.
Additionally, our medium-term models yield the same forecast as at the time of the flash release, projecting inflation a bit above target in the medium term.
The carryover effect from 2024 to 2025 is 1% for core HICP (1.2% on SA data and 1.0% on NSA data) and 1% for headline HICP (1.1% SA and 0.8% NSA). In our assessment, the risks surrounding the ECB/NCBs staff forecast remain balanced.
Evidence from the distributions
The distribution: centered around target. This month, the distribution is less dispersed than in the previous month (see ridge plot). Looking at a longer horizon (Figure 1), the distribution has shown a greater concentration around the target in recent months. This is a notable development, though we remain cautious due to potential residual seasonality effects.
Finally, the median (Figure 2) ticked up in December and remains close to the target.
Overall, this evidence suggests solid near-term readings slightly above target, with MoM (SAAR) expected in the 2.0–2.5% range.
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 model
Our CI model estimates that, excluding idiosyncratic shocks, the common component across items remains solid. Figure 3 illustrates the decomposition of the MoM change in core HICP into its “common” and “idiosyncratic” components.
According to the model, the common component increased by 22 basis points in December, consistent with the average of previous months, while the idiosyncratic shock was negligible (0 bps). As in previous months, we define “true” core HICP as the measure that excludes the idiosyncratic component. Based on this approach, a rough estimate places the MoM (SAAR) for “true” core HICP at 2.6% in December.
The CI model’s signal in recent months aligns with the distribution trends, indicating that core HICP is currently running above target. The good news is that the 3m/3m rate now stands at 2.6% and is trending downward (see Figure 4 below).
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 model, a 2-stage OLS-LASSO regression model.
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 model.
Implications for the medium-term forecast of core HICP
The model-based forecasts remain essentially unchanged from the flash release, as the latest data has not affected the quarterly nowcast. Using the unemployment rate as a measure of economic slack, the forecast projects inflation at 2.5% in 2025, 2.3% in 2026, and 2.1% in 2027. Meanwhile, using the output gap, the forecast stands at 2.5% in 2025, 2.2% in 2026, and 2.2% in 2027. On average, these projections are slightly above the most recent ECB/NCBs staff forecast.
Figure 5. Model-based medium-term forecast of core HICP (YoY)
Using Urate as a measure of “slack”
Using outputp gap as a measure of “slack”
Note: the confidence intervals (C.I.) are calculated using the estimated parameters distributions.
A comparison with the ECB/NCBs staff forecast
Model-based forecast outlook: Persistent in 2024, some upside risks for 2025. Our model-based forecast has remained stable throughout 2024, showing little evolution. However, there are some upside risks for 2025. Table 1 compares our latest model-based forecast with the ECB/NCBs staff forecast. The 2024 carryover effect for 2025 is broadly similar to the 2023 carryover for 2024 for core HICP, while it is slightly higher for headline HICP.
Is the 2025 Forecast Too High? A common question we receive is whether our 2025 forecast is “too high.” To address this, consider the following. Our models estimate slightly higher inflation persistence than the ECB/NCBs forecast, but the difference is not substantial. In numerical terms, the average MoM change in core HICP for 2025 consistent with our forecast is 20 basis points, compared to 17–18 basis points in the ECB/NCBs forecast. This suggests our model’s projection is well within the range of plausible outcomes, especially considering the 1%+ carryover for 2025. For headline HICP, starting with a 1% carryover, the ECB/NCBs staff forecast of 2.1% for 2025 would require relatively low inflation readings (averaging 16 basis points per month). While not impossible, this would be at the lower end of the possible range. By contrast, our model’s forecast of 2.4% would place inflation at the upper bound of potential outcomes.
(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 average of the two models shown in Figure 5.