Sure to Go Back to 2%?
The February HICP report raises questions. The signals from our models are not friendly: the distribution of price changes is less dispersed but around a much higher median. The CI model suggests that the common component is a bit stronger than in previous months and remains above target. Finally, the medium-term models deliver a forecast higher than the latest macroeconomic projection exercise (and higher than target). Not only but services HICP (the “trend” of core HICP) are still running at around 4% saar at the margin (see here and here) with the ECB underestimating the pace (see page 13 in these slides). Demand conditions are changing, at least a bit. But for the time being, we remain unsure whether the Euroarea can reach (and stay) at target.
Evidence from the distributions
The distribution: some unfriendly movement. This month, we do not have a clear signal as some percentiles moved up and some down (ridge plot here), as the distribution is less dispersed around a higher median. In the last 3 months (the black line in Figure 1) the distribution shows some movement to the right. Finally, the median (Figure 2) has increased notably in the last two months, way above target.
Overall, this evidence continues to suggest solid near-term readings above target (MoM saar around 2.5%-3.0%).
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 net of idiosyncratic shocks, the common component across items is stronger than in recent months. Figure 3 shows the decomposition of the MoM of core HICP in the “common” component and the “idiosyncratic” component. The model estimates that in February the common component increased by 25bps, a bit above the average of the previous months, while the idiosyncratic shock is a small negative (-2bps). 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% in February, a bit above the previous months. The signal of the CI model in the last few months is in line with the distributions and suggests that core HICP is running in the 2.5%-3.0% (ar) range at the moment.
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
Medium-term model-based forecast unchanged. Compared to the time of the March governing council meeting, the models forecasts are unchanged. The “main” model forecast (sample ends in Q1)continues to project core inflation to moderate going forward but with no certainty of reaching target. The model forecast using the unemployment rate (average YoY) is: 2.7% in 2024, 2.6% in 2025, and 2.4% in 2026. Using the output gap is: 2.7% in 2024, 2.2% in 2025, and 2.0% in 2026.
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
Risks around the ECB/NCBs forecasts are balanced. Table 1 shows a comparison between our latest forecast and the ECB/NCBs staff forecast. The 2023 carryover for 2024 is 1.1%. This implies that a forecast below 3% for 2024 is reasonable. Going beyond 2024, the models are a bit above the ECB/NCBs staff forecast, as the inflation process is estimated a bit more persistent. Risks around this forecast are very well balanced.
(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.
Implications for the ECB
Celebrating on the 20-yard line? Recent communication from governing council members has been dovish. Having said that, the latest macroeconomic projections did not include the February flash reading, which was certainly not friendly. Not only, but the data continue to suggest that reaching (and staying at target) is not so obvious. For this reason, for the time being, we cannot join the ECB optimism.