Risks Are Still To The Upside
The July HICP report confirms that “the ducks are not in a row” because the NSA level is not cooperating and because the risks around the ECB/NCBs staff forecast remain to the upside. Our models suggest that the distribution of price changes is consolidating the improvements we saw in the last two months, including the median. But we remain careful because progresses in core services are limited (if any). Our CI-C model continues to estimate a “true” core HICP MoM (ar) rate at around 3½% for the third consecutive month.
The next HICP will be crucial. In our estimates, without a downward surprise, the ECB/NCBs staff should have no room to revise down the forecast. In fact, given “acquired inflation” for 2023 we continue to suspect the staff is, once again, at risk of revising up the forecast. For this reason, a hike in September is more likely than not at this point, in our view.
Evidence from the distributions
The distribution: consolidation. Figure 1 shows the distribution of price changes in recent months. The good news is that in the last 3 months the distribution has shifted to the left compared to 6-9 months ago, and the median (Figure 2) has dropped notably. The reasons for being careful is that (i) the distributions are calculated on seasonally-adjusted data (therefore are sensitive to possible residual seasonality), and (ii) the distribution is mainly reflecting the disinflation in core goods.
Overall, the shape of the distribution remains far from pre-Covid, which suggests disinflation will take time.
Figure 1. Kernel of HICP excluding food and energy items changes (%, a.r.)
Figure 2. Median of HICP excluding food and energy items prices increase
Evidence from our CI-C model
Our CI-C model estimates that net of Covid and idiosyncratic shocks, the common component across items in July was in line with the previous months. Figure 3 shows the decomposition of the MoM of core HICP in the “common” component, the “idiosyncratic” component, and the “Covid” effect. The model estimates that in July the common component increased by 17bps, in line with the average of the previous months. The Covid effect is estimated at 10bps, and the idiosyncratic shock is positive (19bps). As we did in previous months, we consider as “true” core the one netting out the idiosyncratic part. Therefore, a rough estimate put the MoM (ar) of “true” core HICP at around 3.3% ar in July, roughly stable compared to the previous two months.
Figure 3. Contributions to MoM changes of HICP excluding food and energy items
Note: the Figure shows the decomposition of the MoM percent changes of HICP prices excluding food and energy items. The contributions are estimated using our CI-C model, a 2-stage OLS-LASSO regression model. The “Covid” effect is identified with price variations outside the 10th-90th percentiles of each item pre-Covid price change distribution.
Figure 4. Estimated “Common” component: YoY, 3m/3m a.r. and 6m/6m a.r.
Note: the Figure shows the 3m/3m at annual rate (green line), the 6m/6m at annual rate (red line), and the YoY (blue line) of the “common component” estimated using our CI-C model.
Implications for the medium-term forecast of core HICP
Medium-term model-based forecast is unchanged. Today’s data imply only cosmetic revisions to the medium-term model-based forecast, as the data came in as expected. The forecast is at 5.2% (Q4/Q4) in 2023 (average of four quarters at 5.3%), 3.7% in 2024, and 3.5% in 2025. The confidence bands (calculated from the estimated parameters distributions) suggest that the risks are still skewed to the upside.
Figure 5. Model-based medium-term forecast of core HICP (YoY)
Note: the confidence intervals (C.I.) are calculated using the estimated parameters distributions.
First quarter of forecast: 2023:Q3.
The NSA issue and a comparison with the ECB/NCBs staff forecast
The NSA level is not cooperating. Figure 6 shows the evolution of the unchained NSA core HICP (see our notes here and here about “unchained HICP”). So far, the cumulative NSA unchained inflation in 2023 is marginally higher than last year with no sign of slowdown. We described it as the “plateau“: inflation is neither accelerating, nor decelerating in NSA space. This is why we are extra careful right now.
Figure 6. Acquired unchained core HICP inflation
Note: the Figure shows the cumulative (“acquired”) inflation in each year, normalized at 1 on new years’ eve. The chart refers to core HICP, NSA. This procedure eliminated the “chain linking” mechanism of the HICP and results in the “unchained” index. For technical details, see our notes here and here.
Risks around the ECB/NCBs forecasts are to the upside. Table 1 shows a comparison between our forecast and the ECB/NCBs staff forecast. As discussed in previous updates, the 2023 ECB/NCBs staff forecast for core HICP is now close to our own. 2023 acquired inflation for core HICP is 4.7%/4.9%. Therefore, the risks around the ECB/NCBs staff forecast remain skewed to the upside. Not only, but (conditional on our 2023 forecast) the 2023 carryover effect in core HICP space for 2024 is 2.4% which means that the 3.0% of the ECB/NCBs staff forecast for 2024 is at risk of being revised up either in September or (most likely) in December.
(For a technical note on the concepts of “acquired inflation” and “carryover effect” see here and here).
Table 1. Comparison of forecasts
Note: the “UnderlyingInflation” forecast refers to the “main” model in Figure 5 (judgmentally adjusted).
Implications for the ECB
ECB seems to be in a similar spot to where it was back in February. Yes, there is a slowdown in the Euro area economy but the re-accelearation of the US is complicating the forecast. Not only, but the ECB/NCBs staff forecast is, in our estimates, once again late or inconsistent (in the sense that it would require a more pronounced slowdown/recession). Moreover, until we will see a real progress in the NSA level, we will remain ultra careful in arguing that there are convincing signs of disinflation. In a sense, the current situation reminds us of where the ECB was back in February when we pointed out how unrealistic the ECB/NCB staff forecast was (our note here). We continue to suspect that at some point the ECB/NCBs staff will be forced to revise up its forecast (or less likely revise down growth significantly) which should trigger an additional hike in September.