To Be The First or The Right One?
The June HICP report brought good news for the third month in a row. However, we are SUPER careful and we are not ready to celebrate. Our models suggest that the distribution of price changes is consolidating the improvements we saw in the last two months, including the median. There are also some progresses through the lens of our CI-C model, which estimates a “true” core HICP MoM (ar) rate at around 3.5% for the second month in a raw. Given the noise in the data and the possible seasonal adjustment issues, we invite the reader to be extra careful.
The reason why we are very careful is that the NSA series is not sending similar signals. Therefore, we would like to see additional evidence before making a call. Right now, the risks remain to the upside around the ECB/NCBs forecast but they are small. Last month (here) we wrote “July is on autopilot, September will be a hold in our view”. We confirm it now. At the moment, we prefer to stay on the sidelines waiting for the next big opportunity.
Evidence from the distributions
The distribution: good news. Figure 1 shows that the distribution of price changes in recent months. The good news is that in the last 3 months the distribution has clearly shifted to the left. Also, the median (Figure 2) has dropped notably. The reason for being careful is that the distributions are calculated on seasonally-adjusted data. Therefore, any residual seasonality would distort the evidence (nevertheless, we run several filters and this evidence seems to be robust).
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 June 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 June the common component increased by 15bps, in line with the average of the previous months. The Covid effect is estimated at 14bps, 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 3.5% ar in June, roughly stable compared to May.
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 5.1% (Q4/Q4) in 2023 (average of four quarters at 5.3%), 3.75% in 2024, and 3.55% 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 in taking signal from Figure 1 and 2. We need some confirmation from the NSA space as well.
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 4.6%/4.8%. Therefore, the risks around the ECB/NCBs staff forecast remain skewed to the upside. Not only, but 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).
Table 1. Comparison of forecasts
Note: the “UnderlyingInflation” forecast refers to the “main” model in Figure 5 (judgmentally adjusted down at the end of the forecasting horizon).
Implications for the ECB
No hedge. If we put everything together, we see a cloudy picture. The SA numbers are sending promising and dovish signals but the NSA series are not benign at all. Not only but the ECB/NCBs staff are so late that the data can force them to revise up again their forecast. To sum up: the stars are not in line yet. One can try to be the first one trading the EA disinflation and in this case, now it is the right spot. Or one can wait a bit more, just to make sure to be right. At the moment, we prefer to stay on the sidelines with our EA call waiting for the big opportunity.