Some good news but the ECB is too late. The May flash HICP report was softer than our expectations, and the filter revised down marginally recent history. The big picture is unchanged because (i) we need to check with the final release the source of the downward surprise (idiosyncratic?), and (ii) the medium-term forecast remains unfavorable. However, for the first time the impression is that we are going sideways rather than accelerating. Going back to target is still a long way but at least we are at the plateau. How persistent this inflationary episode will be is still a question mark and will depend on wage growth and monetary policy.
As for the ECB, it is the paradox of being so late. At the June meeting, the Eurosystem staff will submit a revised forecast. Back in February and in March (see here and here) we explained why by the time of the June meeting “acquired core HICP inflation” for 2023 would have been close to (or higher than) the ECB staff forecast for the entire year. Indeed, after the flash report, acquired core HICP inflation for 2023 is already 4.5% and we expect the new forecast to show an upward revision in 2023 (and possibly in 2024). Back in February/March we wrote: “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 answer is clear to us: whether they like it or not, it would be virtually impossible not to hike with a sizable upward revision to the core HICP forecast, despite the evidence that something might be changing in the incoming data. Welcome to the ECB paradox.
To sum up: The data are finally shown some tentative improvements. But for the time being (that is the next 2 meetings) in our view and estimates the ECB will be forced to hike by the upward revisions to its own forecast.
Details
The plateau is here. We estimate that in May core HICP prices grew 40bps MoM (sa) or 4.9% at annual rate with some downward revisions to previous months (chart of MoM saar here). This brings the 3m/3m (ar) to 5.7% (Figure 1). May is the 23rd consecutive month in which the 3m/3m (ar) runs above the YoY. However, for the first time, the 3m/3m is finally going sideways. On a quarterly basis, we estimate that in Q2 core HICP prices will grow at 5.4% at annual rate. Acquired core HICP inflation for 2023 is 4.5%.
(Important: before jumping to the conclusion that “we are done with inflation”, the reader might want to think about what happened in the US and in the UK. Inflation is a process and it has a persistency, which higher than zero. At the moment, the point is not whether we can go back to target but how long it will take. The answer to this question is what, in our view, will determine monetary policy. For instance, it is very much possible that the YoY of core HICP will go sideways over the summer.)
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).
ECB staff will be forced to revise up (again) its core HICP forecast. Figure 2 shows history of the MoM (sa) of core HICP, together with our own judgmental forecast and the average consistent with the March ECB staff projection. Conditional on our forecast, the YoY is expected to average 5.4% in 2023, 8 tenths above the latest ECB staff forecast (4.6%). In order to meet the ECB staff forecast, core HICP should grow on average 7bps per month going forward, a circumstance which is unrealistic. The good news is that the time for a reality check has come and we do expect the ECB forecast for core inflation to be revised up at the upcoming meeting.
Finally, under our own forecast (blue line in Figure 2), acquired inflation (the “carry-over” effect) for 2024 is 2.0%, which makes the ECB staff forecast unrealistic not only for 2023 but also for 2024. A more realistic forecast for 2024 at this point is already above 3% (as opposed to the 2.5% of the ECB staff forecast).
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 latest ECB staff macroeconomic projections.
Medium-term model-based forecast a touch softer. Today’s data imply a marginally softer medium-term path, as the starting point is lower. The forecast is at 5.0% (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 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:Q2 (our nowcast).
Headline HICP: the risks are to the upside. For brevity, we do not show our judgmental and model-based forecast for headline HICP. The bottom line is that they point to upside risks around the ECB staff forecast, as they both suggest that the average of the YoY could be around 5.7% (as opposed to 5.3% of the latest ECB staff forecast).
Implications for the ECB staff and monetary policy: the paradox of being so late. The paradox is the following: the ECB is so late that it will be forced to hike even if the data are finally softer (Lagarde’s speech today is a confirmation, even if it was written before the May report). The Governing Council will receive new forecasts and, as mentioned above, we expect a pretty large upward revision to core HICP in 2023 (and possibly also to 2024). Many will point to the fact that the YoY of core HICP has ticked down but what drives monetary policy is the medium-term outlook which remains unfavorable. Going forward, we do expect some moderation (as discussed after the April final HICP, given the evidence from the distributions – see here). Translated: we suspect that the data will finally start cooperating as they did in the US. But monetary policy and the ECB/Eurosystem staff are so late that the path for the next two meetings seems unavoidable. After that, at this point it is possible the doves will come back and ask for a pause. They might get it, until it will become clear whether core HICP has a chance to go back to target in a reasonable amount of time.