Exclusive: ECB Insider: Some Indicators Suggest Core Inflation Momentum Not Weakening

1 March 2023

Exclusive: ECB Insider: Some Indicators Suggest Core Inflation Momentum Not Weakening
- ECB insider: Core inflation to remain relatively high and away from our target this year
- ECB insider: Some concerns that wage demands could pick up quickly in 1H
- ECB insider: Increasing trend of firms protecting their margins contributing to price pressures
- ECB insider: Hawks ‘not very comforted’ by assurances of lower medium-term price pressures
- ECB insider: Some hawks question medium-term inflation outlook due to 2d-rd effects, energy prices

By David Barwick – FRANKFURT (Econostream) – The discussion at the European Central Bank Governing Council’s monetary policy meeting this month, likely to be difficult in any event as the ECB faces a potential inflection point in the current tightening cycle, will be rendered more complicated by the outlook for core inflation, according to an ECB insider who spoke recently to Econostream.

An important question confronting policymakers is no longer so much when underlying price pressures will peak as it is how long these will persist before finally subsiding, he said.

‘We have had some indicators that say that the momentum of core inflation is not weakening’, he said. ‘We perceive that the core components and the pressures there are and will be relatively strong. We don’t see any big decline this year. I think we can all be sure that core inflation will remain relatively high and away from our target.’

There was a legitimate danger of core inflation being sustained in part by workers’ efforts to recover real purchasing power lost last year, he said. Although such a wage-driven price spiral has not yet clearly emerged in the euro area, ‘in some countries there is a perception that this could accelerate fast in the first half of the year’, he said.

This is in any case not the only potential source of an inflationary spiral, he said. In some parts of the area, ‘there is an increasing trend’ of firms out to protect their margins that is ‘contributing more and more’ to price pressures, he said.

All this makes the new macroeconomic projection exercise and the narrative relied on to support any decision more difficult, he said.

Policymakers who are hawkishly inclined will be less amenable to being reassured by a medium-term slowdown of inflation as they focus on alarming current data, whereas the more dovish members will gladly point to weaker price pressures at the forecast horizon and argue that this outlook reduces the need for further policy tightening, he said.

Indeed, he said, the clearest difference lately between hawks and doves has to do with the respective importance attached by them to spot inflation data as opposed to medium-term prospects, he said. In the context of current inflation of around 10%, he said, the hawks are simply ‘not very comforted by analysts saying, “Don’t worry, this inflation is going to go down to 2% in the relevant horizon.”’

Some among them, ‘partially influenced by the actual data, think the medium-term outlook could be wrong, because the second-round effects will be bigger, the energy pressures will be bigger, this kind of thing’, he said. ‘So, it’s a matter of believing the current trend or believing the medium-term outlook.’

Other arguments would enter the discussion, he said, including of course the view that it simply made sense at the present juncture to take a step back and assess the impact of the significant monetary policy steps already taken.

Some members would counter this with the observation that the prevalence of household and corporate debt at fixed rates, the existence of buffers and the support of fiscal policy all made monetary policy less effective than in the past, he said.

These arguments were in turn subject to question by those who see the buffers as having run their course or who consider the pass-through of monetary policy to the debt of firms and households as very far from complete and likely to accentuate vulnerabilities down the road, he said.

Some Council members will want to leave open the door to slowing in May to 25bp, whilst others ‘will think that we are still very far from the terminal rate’, he said. It could prove harder to come up with communication that satisfies all sides, he said.

Although the expected 50bp hike this month is ‘not a final decision’, he said, ‘we are pretty sure that no matter what the forecast is, the 50bp is granted.’ There was no reasonable outcome to the latest projection exercise ‘that would give us a different outcome from 50bp in March’, he said.

‘Beyond that, it’s fair to reassess, and here of course there will be members of the Governing Council who want to be surer than others about the weakening of inflation dynamics in terms of adjusting the pace.’

This will distinguish the discussion from that of preceding meetings, he said, ‘when everyone was committed to the same path and the same direction’.

Now, there will emerge more fundamental, ‘structural’ disagreement between those increasingly inclined to slow the pace of hikes, if not stop tightening altogether, and those still convinced of the need to maintain the recent tempo, he said.

In the end, the communication following the March policy meeting would have to ‘be decided very deeply’ with respect to ‘every single word’, he said. References akin to ‘significantly at a steady pace’ were likely to be dropped, he indicated.

‘There will be a more conceptual discussion, also in light of the discussion that we had in February, about how consistent we are in saying that we are data-dependent and that we go meeting by meeting if we then give a very clear forward guidance’, he said.

‘For me it was very convincing the fact that uncertainty is so high that that nobody can pre-commit for a long period of time to any kind of a strong decision’, he said. Pre-committing entails a heightened risk of ultimately having to deviate, a fate the ECB has not been immune to, he noted.

‘So, why do we want to get into that mess again?’ he wondered. ‘Some kind of guidance would be fine, but of the very soft sort. There’s a quite fine line between providing some guidance to reduce uncertainty and pre-committing to what is essentially forward guidance.’