Preamble. A new equilibrium.
While we are frequently asked to comment on individual data points—and are always glad to do so—it is valuable to periodically step back and consider the broader picture. The chart below illustrates the level of CPI for fresh bread in Italy, a category characterized by high persistence and minimal seasonality. In essence, this is where we stand: prior to the pandemic, prices increased at a stable pace of approximately 1% year-over-year. The COVID period marked a structural break in the level, followed by a change in the slope—price growth has since stabilized at a new, persistent rate of around 2% year-over-year.
This example is indicative of a broader trend that spans a wide range of goods and services categories. For instance, similar dynamics are observable in Italian CPI rents (see here). In many ways, the chart below encapsulates the core message of our euro area analysis over the past two years. The data—and our models—continue to signal the same underlying shift: the euro area appears to have transitioned to a new regime in which (core) inflation is now anchored around the ECB’s 2% target.
As Expected. The July final HICP matched the flash figures. This confirms our initial view and doesn’t change our overall assessment. The data distribution hasn’t shifted much lately and is still centered around target. Our CI model also matches what the distribution shows. We continue to expect month-over-month annualized inflation readings to stay close to the ECB’s goal in the near term.
Looking ahead, the ECB and national central banks now have core inflation forecasts that are largely in line with ours. We see the risks around this outlook as balanced. However, our models do project slightly higher overall (headline) inflation for next year compared to what ECB and national staff currently expect.
Overall, we think the ECB is staying cautious for now, taking a “wait-and-see” approach with no need to cut rates in September or possibly for the rest of the year.
Evidence from the distributions
The distribution: centered around target. This month, the distribution is similar to the previous month (see ridge plot). Looking at a longer horizon (Figure 1), the distribution shows little movement in the last 9 months and remains concentrated around the target.
Finally, the median (Figure 2) moved sideways in July and the YoY remains close to the target.
Overall, this evidence suggests solid near-term readings, with MoM (SAAR) around target.
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 15 basis points in July, a bit below the average of previous months, while the idiosyncratic shock is small and positive (3 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 around 2% in July.
The CI model’s signal in recent months aligns with the distribution trends, indicating that core HICP is currently running around target or a bit above it. The good news is that the 3m/3m rate now stands at 2.1% (see Figure 4 below) and we expect it to move sideways going forward.
An Excel file containing the results of the CI model is here.
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.
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 forecast is little changed from the flash release.
Projections based on the unemployment rate (average YoY) indicate: 2.4% in 2025, 2.1% in 2026, and 2.1% in 2027. Meanwhile, forecasts using the output gap indicate: 2.4% in 2025, 2.0% in 2026, and 2.0% in 2027.
These projections are close to the most recent ECB/NCBs staff forecast for 2025 and a bit above them in 2026 and 2027.
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
Comparison with ECB forecasts. Table 1 compares our latest model-based forecast with the ECB/NCBs staff forecast. With the July data, we estimate acquired inflation for 2025 at 2.2% for core HICP (sa, and 2.2% nsa) and 2.0% for headline inflation (sa, 2.0% nsa). Acquired inflation for 2025 supports the revised ECB/NCBs staff forecast for this year. This implies that mechanically the 2025 ECB/NCBs staff forecast is unlikely to be revised down going forward. However, the upside risks at this point appear limited for 2025.
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.