EZ HICP Review: Headline Rise Capped by Food & Energy, Services Jump Seasonal?
Even given what seem to be a series of reassuring aspects, the May flash HICP data is unlikely to have a material impact on ECB thinking. As expected, and helped by German fuel subsides which kept the energy rise to around zero, headline HICP rose just 0.2 ppt to 3.2%, still a 32-mth high, but where softer food prices and stable non-energy goods helped temper what were higher services inflation (up 0.5 ppt to a six-mth high of 3.5%). This latter increase is obviously unwelcome and will reverberate among the ECB hawks whose talons now dominate the Council to a degree where a rate hike this month is all but sealed. But we think that the services jump is partly seasonal (Pentecost holiday was early this year and is normally associated with steep airfare rises). Moreover, the headline may now be close to having peaked, not least as a marled fall in diesel prices in late May could take 0.2 ppt of the y/y rate in June.
Figure 1: Headline Higher Again And Core Up Modestly Too
Source: Eurostat, CE
This services jump caused a small but expected rise in the core too, albeit where the resultant core of 2.3% (0.2 ppt up) means an apparent double-whammy in that both it and the headline would be above existing (ie March) projections for Q2. But the ECB (via Chief Economist Lane) has already noted that those projections are out date whilst also highlighting various statistical methods to suggest that energy-induced price pressures are already starting to broaden out (Figure 2), albeit something we do not see being backed up by actual data, most notably short-term adjusted HICP figures (Figure 3). Moreover, the jump in services is probably a seasonal feature, unwinding base effects related to the timing of Easter and then Pentecost.
In addition, retail fuel prices may now detract from inflation in June given the sharp fall back in diesel prices seen of late and where relatively stable gas prices do not suggest any imminent jump in this category of energy costs. Furthermore, another reassuring aspect is the lack of any sign of (very much import sensitive and supply chain driven) non-energy prices starting to rise. With this in mind, we see the headline at around 3.3% this month and staying in that vicinity until early 2027, but where favourable base effects could pull the overall y/y rate back down toward, if not below, 2% next spring
But given what are we are still unresolved evens in Middle East, we accept risks not least stemming from our assumption of the Iran conflict (the Straits of Hormuz opening up by end-July), with perhaps the extent and form of any end to hostilities being the key conundrum. While tilted to the upside, this produces risks on both sides but those possibly precipitating second-round effects, we note the marked contrast in the labor market and consumer price expectations compared to the inflation surge that followed the invasion of Ukraine four years ago. Of course, and as survey have highlighted cost rising fast, but nowhere near as much as seen in 2022 (Figure 2).
Figure 2: Cost are Surging, but Perspective Needed
Regardless, and arguing against any clear wage spiral emergence, an ever-wider array of survey data suggest also that job losses are also starting to become worryingly widespread as business confidence in any swift turnaround in the adverse economic climate fades further. Notably, the service sector is being hit especially hard by the cost surges created by the war. Moreover, what is even more notable is that supply shortages not only pose upside risks to prices but can and seem to be constraining real activity already growth already and probably more so in the coming months but also have the potential to add further upward pressure to inflation. With this in mind, how the ECB revises it real economy outlook on June 11 month will be as important as how inflation is altered, the former very much helping determine both the size and persistence of any prove shock – one that does seem to be increasingly supply related.
But the ECB is seeing a clear and wider price shock. It is using so-called Quantile Regression Forests, an advanced machine learning and AI tool integrated into the ECB’s forecasting toolkit. It is used to generate real-time, short-term inflation projections and to "nowcast" GDP growth and its latest result suggest a core rate rising to 3% before year end, almost a full ppt above that projected in March. Even so, actual HICP data are still showing no such signs, but the ECB is more mindful of its credibility and it does look almost nailed on for at least one hike in June, the question being if another will follow soon after!
Figure 3: Core HICP Messages Still Benign
Source: Eurostat, CE