ECB delivered 50bps, ECB staff revised up core HICP forecast only marginally, as expected. The ECB staff has revised up its 2023 core HICP forecast only marginally, as we expected. The new forecast (for both 2023 and 2024) is even more unrealistic than the one submitted in December, see below for details. The Governing Council has delivered 50bps, in line with what the inflation situation requires. However, the issue starts now. By submitting (again) an unrealistic forecast, the ECB staff is misguiding policy by conveying a false sense of hope. Net of financial stability concerns, the ECB staff is putting gasoline on the fire by making monetary policy constantly late (do not complain, it can be a gold opportunity). What will happen in a few months when the ECB staff, the governing council (and possibly markets too) will be forced by the data to realize that inflation is not so benign and revise up, once again, the forecast? If the ECB will stay “entirely data dependent” (as Lagarde said today), then there should be little doubt about the direction of rates, as well as that a 4% terminal rate is probably not enough.
The new ECB staff core HICP forecast is even more unrealistic than the December one. The 2023 core HICP forecast has been revised up from 4.2% to 4.6%, as we expected (see here). For the record, the forecast was updated by the ECB staff (as opposed to the NCBs staff), and this is why we expected a marginal revision. Having said so, our point is simple: the ECB staff forecast is completely implausible. Indeed, it is so implausible that raises the basic question whether the staff understands the situation or basic notions such as “acquired inflation”. We fear the answer is no. Figure 1 shows what 2023 acquired core HICP inflation could be in April (left panel) and May (right panel), assuming that the MoM in the next 2-3 months will be as in February (56bps). The level of the series in Figure 1 is seasonally adjusted in-house. The takeaway from Figure 1 is simple: we just need a couple of months like February (which is very much possible given that the price distribution is centered around 5-6% at annual rate (see here)) to be at or above the ECB staff forecast for the entire year. In Figure 1, 2023 core HICP inflation (indicated as “Av YoY”) is at 4.5% in the scenario on the left-hand side and 4.9% on the right. This is how wrong the ECB staff forecast is: by the time of the June exercise, acquired core HICP inflation will be above the forecast for the entire year released today.
Figure 1. Simulated acquired (core HICP) inflation in April and May 2023
A more plausible forecast is 150bps higher than the new ECB staff projection (and still, it is probably too generous). Figure 2 shows our revised core HICP forecast (blue line) together with the MoM consistent with the new ECB staff forecast for 2023 (the dashed red line). In this new judgmental forecast, we assume that inflation has peaked and that it will be trending down with a deceleration proportional to its acceleration (around 2bps MoM per month). By construction, this new forecast is quite generous because not only it assumes that inflation has peaked (there is virtually no evidence of that) but that it will not plateau. In this revised forecast, 2023 core HICP inflation is at 5.9%, almost 150bps higher than the ECB staff. And still, chances are to get an even higher 2023 core inflation rate at the end of the year. Not only, but conditional on this forecast, acquired inflation for 2024 is at 2.4%, which implies an implausible zero-growth MoM in each month of 2024 to meet the new ECB staff forecast for 2024. (for the record, this is why we insist so much on the notion of “acquired inflation”).
Figure 2. Revised core HICP forecasts
An unrealistic forecast is an opportunity. The question is simple: what will happen in June when the ECB staff will be forced to revise up (and probably not marginally so) its core HICP inflation forecast? The ECB staff forecast is not marginally wrong; it is completely wrong. Chances are that the ECB will be constantly surprised up by inflation in the next (at least) 6 months. If the ECB is truly “data dependent”, the path going forward (net of financial accidents) is clear.