Cut With Lots of Risks. We expect the ECB to cut rates (25bps) at the upcoming Governing Council. As for the staff forecast, revisions should be minimal and cosmetic (“acquired inflation” for 2024 signals no room for revisions). If anything, the staff might edge down the forecast for headline inflation but in this case, we will not take any signal. For core HICP, the incoming data have been stronger than implied by the June forecast and the risks remain to the upside, especially in the medium-term. For this reason, we would consider a mistake a downward revision to core HICP at any horizon.
In a nutshell: in our view the ECB will cut in September, and we expect it to remain “data dependent”. But the issue remains the same: is the Euro area going back to target? Can the ECB keep ignoring the signals from HICP services? Hard to think the September governing council meeting will be able to provide any real guidance. We remain skeptical.
Main points:
The incoming data on core HICP have been a bit 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 2.4 percent, revised down marginally compared to last round. 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 2-3 times in 2024. Non inertial Taylor rules suggest more cuts.
Figure 4. Taylor rules
