Data for core HICP came in very hot, as we expected. Near-term and medium-term forecasts very unfavorable. The February flash HICP report confirms that core inflation is getting out of control (close to 7% at annual rate, a bit above the distribution of price changes we have commented with the final HICP for January, signaling that price pressures are increasing). As we wrote recently, any attempt to minimize what is happening is entirely out of touch with reality at this point. The situation is extremely dangerous and we fear there is no understanding of what are the real causes of inflation in the EA – no, it cannot be that “it is only/mainly” about negative supply/energy shocks” (we will circulate a note tomorrow about this paper by Riccardo Trezzi (University of Geneva) and coauthors).
In our view, monetary policy should wake up and finally become ultra hawkish (4% terminal rate is probably not enough to stop this episode without a significant help from fiscal policy). A refuse to accept reality (as Lagarde incredibly did in January) would make everything even worse. Inflation is breaking bad, where is the DEA?
Details
Still trending higher, very persistent process. We estimate that in February core HICP prices grew 56bps MoM (sa) or 6.9% at annual rate. This brings the 3m/3m (ar) to 6.1%. February is the 20th consecutive month in which the 3m/3m (ar) runs above the YoY, suggesting there is still room for the YoY to tick up again in the coming months. On a quarterly basis, we estimate that in Q1 core HICP will grow 6.2% (QoQ, ar), about 1pp higher than 2022:H2 and about 2pp higher than 2022:H1. As Larry Summers would put it: last month is higher than last 3 months which are higher than last 6 months which are higher than last year. “Acquired core HICP inflation” for 2023 is 3.3%.
Please also note that at this point any comment about sectoral details (which will be published on March 17th) is in our view irrelevant. In this cycle “macro” wins over “micro”: the top-down models have performed much better than the bottom-up models. Ultimately, 1 Euro not spent in a sector must go somewhere else. Not only, but: (i) labor market data (see today’s figures from Italy here) confirm we have the best labor market of the last 20-30 years, (ii) (negotiated) wages are set to accelerate and get as high as 5%+ this year and possibly beyond depending on the negotiations, and (iii) in some countries (i.e. Italy) pensions are COLA and they have just started to increase. All told: is there a single good news for the ECB? We strongly doubt it.
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). The latest point on the chart is February 2023.
ECB staff will be forced to revise up (big) its core HICP forecast. Figure 2 shows history of the MoM (sa) of core HICP, together with our own forecast and the average consistent with the December ECB staff projection. Conditional on our forecast (which is already quite generous), the YoY is expected to average 5.7% in 2023, 1.5 percentage point above the latest ECB staff forecast (4.2%). We estimate that the ECB staff has been upwardly surprised by the incoming data (Dec, Jan, and Feb flash) by at least 5-6 tenths (sa) in just 3 reports. As we wrote here, at this pace core HICP is set to overshoot the 2023 ECB staff forecast by about 200bps. For this reason, in our view, Lagarde’s words today and even more ECB Visco’s words yesterday reflect the “La-La land” where they seem to live and not the reality of the data.
Figure 2. 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 forecast. The red-dashed line shows the forecast consistent with the December 2022 ECB staff macroeconomic projections.
A model-based forecast confirms that the risks are to the upside for core HICP. Our EA “main” Phillips curve model forecast is at 5.7% (Q4/Q4) in 2023 (average of four quarters at 5.7%), 4.5% in 2024, and 4.1% in 2025. Today the model revised up its forecast in each year as the starting point (Q1) is higher and the estimated persistency of the process is also higher. The confidence bands (calculated from the estimated parameters distributions) also suggest that the risks are skewed to the upside.
Figure 3. Core HICP: YoY forecast of our “main” Phillips curve model.
Note: the figure shows 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:Q1 (our nowcast).
Headline HICP: the (very small) risks are to the downside. For brevity, we do not show our judgmental and model-based forecast for headline HICP. The bottom line is that they now point to very small downside risks around the ECB staff forecast, as they both suggest that the average of the YoY could be around 6.1% (as opposed to 6.3% of the ECB staff forecast).
Implications for the ECB staff and monetary policy: time to wake up and follow the Fed. What we are witnessing in the Euro area seems a replay of what happened in the US. There are clear differences, of course. But there is something in common: the ECB staff is late and continues to be surprised by the incoming data (of core inflation) to the upside. In the next few months, headline inflation will moderate due to base effects and lower energy prices. But the real game is with core inflation, expectations, and wages. Right now, the ECB is losing. Time to wake up and follow the Fed.
(For the record, this last paragraph is a copy/paste from last 2 months and we suspect it will remain unrevised for few months going forward)