Cut, Growth Concerns Rising. Upside Risks to Inflation Remain. The Governing Council seems committed to cut rates again at the upcoming meeting. The story for this round seems identical to the last couple of rounds: the incoming data have broadly validated the latest ECB/NCB staff forecast, but the downside risks around the outlook for growth have increased. At the same time, services inflation is very sticky and a question mark remains whether the EA can reach and stay at the 2% target going forward. (For the record: we remain agnostic whether the EA will experience a recession or not. Without a shock, we continue to think that, if any, the recession might be mild and inflation can remain around target).
As for the ECB/NCBs staff forecast, this time we expect only cosmetic changes, if any.
Main points:
The incoming data on core HICP have been roughly in line with the latest ECB macroeconomic projection exercise. We estimate that core HICP prices are running at 2½+ ar, with strong services readings (4% ar sequential). “Acquired inflation” for 2024 implies little room for the ECB/NCB staff to revise down the 2024 forecast.
Figure 1. Evolution of cumulative unchained core HICP by year (index =1 on New Year’s Eve).
The main model medium-term forecast is little changed compared to last round. The “main” model forecast is largely unrevised, as the incoming data have been in line with the model own forecast. The model forecast is above the latest ECB/NCBs projection and remains higher than target at the end of the medium-term.
Figure 2. Current vs previous GC round “main” model medium-term forecast of core HICP.
Note: the figure shows the model forecast of core HICP (YoY) in the current round (left panel) and the previous GC round (right panel). The red shadowed areas show the intervals of confidence from the estimated parameters distributions.
Trend inflation models. The average of the models in Q4 is 2.3 percent, down marginally compared to last round and the previous quarter. The estimate of “trend inflation” implies a core forecast above the ECB/NCBs staff forecast at the end of the medium-term.
Figure 3. Trend inflation models as in Rudd (2020) for the Euro area.
Note: the chart shows the estimated trend inflation from econometric models as in Rudd (2020). The models are split into three groups. The first group is a collection of Phillips-curve (PC) type of trend inflation models in which a measure of long-term inflation expectations is used as a proxy of trend inflation. The second group is a collection of state-space unobserved component models in which we have modelled trend inflation either as a smooth trend or as an augmented local level. Finally, the third group of models is a collection of Time Varying Parameters Vector AutoRegressive models (TVP-VAR) with different endogenous variables. This set of models follows the FEDS Note by Rudd (2020) “Underlying Inflation: Its Measurement and Significance”.
Taylor rules imply 3-6 cuts in 2024. This is unchanged compared to last round. The governing council seems committed to cut rates again at this meeting, given growth concerns. The inertial Taylor rules conditional on (i) the degree of inertia consistent with observed path of the ECB deposit rate, and (ii) on a forecast for core inflation as in the “main” model suggests that the deposit rate might be cut 3 times in 2024. Non inertial Taylor rules suggest more cuts.
Figure 4. Taylor rules
