Good News With Question Marks
Good news, question mark remains. The October flash core HICP figure came in just a bit below our expectations (NSA level 117.32 vs 117.42 expected by us – apologies but we could not circulate a preview). October is the third month of positive news. Having said so, even factoring in the recent developments, the models continue to deliver a forecast which remains above target at the end of the medium-term. Admittedly, the model using the output gap is now at 2.1% (average YoY) in 2026. Therefore, with another good news in November, it is possible to see the NCBs staff forecast being revised down to target at the end of the medium-term. In any case, to our eyes, the October flash HICP report contained also some unfriendly news, as the evolution of HICP services (including sequential readings, see below for details) continues to be inconsistent with the ECB target. Putting everything together: good news but still not enough to change the ECB message in December. For now, in our view and estimates, the “for longer” strategy continues to be the correct one in terms of risk management.
A PDF containing all relevant charts can be downloaded here.
Details
Good news, November reading will be very important. We estimate that in October core HICP prices grew 27bps MoM (sa) or 3.3% at annual rate, just a touch softer than the previous 2 months (see here and Figure 1). This brings the 3m/3m (ar) to 3.9% (Figure 2). The 3m/3m (ar) continues to be below the YoY, signaling that the annual variation should moderate further in the coming months. Acquired core HICP inflation for 2023 is 5.0% (on both SA and NSA data). The evolution of the NSA unchained index in 2023 is now similar to 2021 and extrapolating the latest readings forward does not solve the question of whether the EA can go back to 2%.
(For the record, we now expect the YoY of core HICP at 4.0% in December 2023)
The unpleasant news in today’s report is that HICP services (which is the real “trend” of the series) continue to be unfriendly and growing at around 4% at annual rate (see here for NSA unchained index and here for MoM saar chart). Overall, the November print will be very important as the NSA level used to drop significantly pre-Covid.
Figure 1. Core HICP NSA unchained index by year.
Note: the figure shows the evolution of core HICP by year, normalizing the index at 1 on new year’s eve. The shadowed portion of the blue line in 2023 indicates our forecast.
Figure 1. Core HICP metrics.
Note: the figure shows the metrics of core HICP. All figures are seasonally adjusted. “ar”” stands for “annual rate”. The 3m/3m and the 6m/6m are chained (that is, using the US BEA method).
ECB/NCBs staff forecast for 2023 looks a bit high now. Figure 3 shows history of the MoM (sa) of core HICP, together with our own judgmental forecast and the average consistent with the latest ECB/NCBs staff projection. The YoY is now expected to average 5.0% in 2023. For the first time, this forecast is a touch lower than the one of the ECB/NCBs staff forecast. Conditional on this forecast, the “carry-over effect” for 2024 is 1.7%.
Figure 3. Core HICP MoM (sa, %).
Note: the figure shows the MoM (sa, not annual rate) of core HICP prices. The blue line shows history and our own bottom-up forecast. The red-dashed line shows the forecast consistent with the latest ECB staff macroeconomic projections.
Medium-term model-based forecast is revised down but still, does not converge to 2%. Today’s run is the first time in which we put 2023:Q4 in-sample; therefore, it is an important run because it “set the tone” for the current quarter. We are assuming that core HICP will growth 3.3% saar in Q4. Our nowcasat is 1 tenth lower than what the model forecasted for Q4 yesterday (that is, stopping the estimation in Q3). All other assumptions about the exogenous variables are unchanged.
Conditional on our nowcast for the current quarter, the model forecast using the output gap as a measure of “slack” (Figure 3 right panel below) is at 4.3% (Q4/Q4) in 2023 (average of four quarters at 5.0%), 3.1% in 2024, 2.3% in 2025, and 2.1% in 2026. Using the unemployment rate (Figure 3 left panel) produces a similar forecast in 2023 and 2024 but a higher forecast in 2025 (this happens because in the latest ECB/NCBs staff projections the Urate goes sideways in the forecast).
Figure 3. Core HICP: YoY forecast of our “main” Phillips curve model.
Using Urate as a measure of “slack”
Using outputp gap as a measure of “slack”
Note: the figures show the YoY forecast of our “main” Phillips curve model for core HICP price inflation. The confidence intervals are calculated from the estimated parameters distribution. Last quarter in-sample is 2023:Q4.
Implications for the ECB staff and monetary policy
Very hard to see a different message in December right now. If we put everything together, in the last 3 months (Aug-Sep-Oct) we finally got some good news (admittedly, after 400bps of hikes and with a stagnating economy it is not so surprising). However, under the surface the fundamental question mark remains: is the EA going back to 2% or will it land on a higher inflation rate? In December, for the first time, it is possible that the NCBs staff will not revise up their inflation forecast (or let it unrevised and cutting growth). At this point, it is very much possible to have a core HICP forecast at 2.0% in 2026 in the next macroeconomic projection exercise (for the record: we still see an issue with the 2024 forecast, given the carry-over from 2023). But overall, when we put everything together, including the risks, right now it is very hard to see the ECB recalibrating its message in December. For now, in our view, it is still “for longer”.