EZ HICP Preview (Feb 1): More Core Disinflation Signs As Headline HICP Fall Resumes?
There has been repeated positive EZ news in the form of plunging inflation. After coming in lower than envisaged for the third successive month, the December HICP inflation instead were in line with consensus thinking. Having dropped 0.5 ppt to a 28-month low of 2.4% in November, this was exactly reversed in December by energy related base effects (Figure 1) but with the core hitting a 21-mth low of 3.4%, still symptomatic of a plunge in underlying inflation that is occurring faster and more broadly than had been ECB thinking, now encompassing not only falling core rates but also softer persistent inflation signals, the latter a key consideration for the ECB. Tus is likely to have continued with the January HICP data where lower fuel costs should more than outweigh modest VAT hikes. Indeed, we see the headline down to 2.6% and the core down to a 21-month low of 3.2%.
Figure 1: Headline and Core Inflation Falling?
Source: Eurostat, Continuum Economics
On-Target Inflation Looming!
Moreover, we now envisage that the headline may now hit target before mid-2024, well over a year earlier than the ECB envisages, while the core should continue to fall in the interim regardless. There are ever-clearer signs of softer underlying inflation both in terms of persistent price pressures which are now running below the 2% target.
Baseless Base Effects
Indeed, in the December HICP data, the core rate hit a low of 3.4%, down 0.2 ppt on the month and down two ppt in the last 3-4 months. But this disguises an even clearer fall in recent price dynamics, as seen in m/m seasonally adjusted data (Figure 2), and with the smoothed core rate now consistent with an undershoot of the 2% target, albeit possibly stabilising at around 0.1% in m/m terms. The ECB instead continues to (at least overtly) focus on y/y rates despite the ensuing limitations from spurious base effects, although the adjusted data is widely used by the likes of Chief Economist Lane and was clearly mentioned in the minutes to the last ECB meeting and may again in the meeting this month. In other words the ECB is letting its inflation analysis be affected as much (if not more) by developments that happened up to 12 months ago rather than in the last month or so.
It could be argued that using m/m adjusted data would place too much emphasis on what may be an aberrant monthly observation. But this applies equally to y/y rates too as the base effects may just as much reflect aberrant observations. In addition using a smoothed (ie 3-mth mov avg) would give a clear idea of recent trends when using adjusted m/m data (as we have been using for some time). Notably the core rate on this basis has been running at around 0.1% m/m for the last few months on average and we think this will still be the case in the January numbers.
Figure 2: Smoothed Core m/m Price Pressures Running Below Target
Source: ECB, CE