Preamble: Please, note that we have introduced a set of trend inflation models for the Euro area (see Figure 3).
The data do not validate the June forecast. We expect the governing council to take time at the upcoming meeting and describe the incoming data as “broadly in line with the June forecast”. In reality, the incoming data have been stronger than implied by the ECB/NCBs staff forecast and the risks around the September macroeconomic projection exercise are to the upside (indeed, “acquired inflation” for 2024 is already equivalent to the ECB/NCBs staff forecast for the entire year). Looking at the medium-term, both the trend models and the “main” model signal no certainty of reaching and staying at target (as opposed to a bit above it).
In a nutshell: the ECB can cut in September, although it would be very weird to do so while revising up again the forecast. But the issue remains the same: is the Euro area going back to target?
Main points:
The incoming data on core HICP have been stronger than implied by 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 is now equivalent to the ECB/NCB forecast for the entire year.
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 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 Q2 is 2.6 percent. 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”.
The Taylor rules imply 2-6 cuts in 2024 depending on the degree of inertia. 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 twice in 2024. Non inertial Taylor rules suggest more cuts.
Figure 4. Taylor rules
