Unexpectedly high inflation rates put pressure on ECB
The inflation data for January were shocking. Instead of falling from 5.0% YoY to 4.4% YoY as predicted by the Bloomberg consensus, consumer prices increased 5.1% from last January. Consensus estimates were probably never that far away from the actual real figure. The increase in the inflation rate can largely be explained by higher energy prices, which rose by 6.0% MoM in January alone. While core inflation was lower than it had been in December, the decline was less than expected. This highlights the breadth of price pressures, which largely originate from the ongoing supply bottlenecks.
Producer prices for December were published this week and confirm this trend. Having risen 2.9% MoM and 26.2% YoY, the increase is the most extreme seen in the last 25 years. Even with the exclusion of energy prices, producer prices increased by 10.0% YoY, with many intermediate goods also becoming more expensive. Given these inflation data, it doesn’t come as a surprise that price expectations for the coming months are also at very elevated levels. Price expectations should be interpreted carefully as survey respondents often have very adaptive expectations – meaning that they simply extrapolate recent trends. Still, this time it is happening against the backdrop of a relatively tight labour market. In January, the unemployment rate fell to 7.0%, its lowest level since the start of EMU and almost certainly the result of the expansionary economic policies implemented to combat the adverse economic effects of the pandemic. Wages are not currently rising and are not likely to see a material increase this year as few wage negotiations are scheduled to take place in the coming months. But this may just be a matter of time. An increasing number of companies, both in the service and the industrial sector, have reported labour shortages. After years of miserable wage growth it will be surprising if employees do not make any salary demands to compensate for higher prices.
Finally, GDP data for 4Q 2021 was also published this week. At 0.3% QoQ, it was close to our estimate and confirmed that supply bottlenecks and high energy prices weigh on household spending and corporate investments alike. For the first quarter, we are only slightly more optimistic, but we expect a strong rebound in the second quarter as COVID restrictions are likely to be eased in most countries and COVID infections fall due to a higher degree of immunity and warmer weather.
At its policy meeting, the ECB has taken note that (i) inflation is much stronger than expected
at the time of its latest macro projections, (ii) the labour market is getting tighter and (iii) there are favourable perspectives for economic growth. President Lagarde opened the door for a tightening of its monetary policy at the coming meetings. She refused to repeat her message that a rate hike is very unlikely this year and also didn’t push against market pricing. But she also dampened early rate hike expectations by (i) confirming rate hikes would only occur following the end of asset purchases (ii) referring to the low wage growth environment and (iii) stating that she doesn’t want to see the ECB “rushed into a process”. The absence of wage pressures would confirm that little has changed for underlying inflationary trends, such that numbers for 2024 are unlikely to be revised up before June or September. As a result, conditions for an earlier rate hike have not been met. However, the current economic data does not support a continuation of asset purchases. We consider a faster reduction of bond purchases to be appropriate. As a consequence, our policy rate forecasts are also under review.
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