Hard core: Underlying price pressures to extend ECB rate-hiking cycle

Eurozone core inflation rates reached new record highs, according to February's flash Harmonised Index of Consumer Prices (HICP) data.

With many of the alternative metrics in S&P Global Market Intelligence's Inflation Risk Dashboard also jumping, the European Central Bank's (ECB) policy rate-hiking cycle is likely to be extended well beyond the next meeting in March.

Core rates still climbing

While HICP inflation fell for the fourth straight month in February, the decline was only marginal (8.6% to 8.5%), with inflation overshooting the market consensus expectation (8.2%).

Another drop in the energy inflation rate (18.9% to 13.7%), which is now almost thirty percentage points below its March 2022 peak, was the only good news in the data.

Food inflation rose to yet another all-time high (14.1% to 15.0%) as did the core inflation rate excluding energy (7.3% to 7.7%).

The more familiar core rate excluding energy, food, alcohol and tobacco prices hit a new high too (5.3% to 5.6%), also overshooting the market consensus expectation (5.3%).

Both core components rose to new highs. Non-energy industrial goods (NEIG) inflation edged up (6.7% to 6.8%), while services inflation rose markedly (4.4% to 4.8%).

Our alternative metrics

The key takeaway from January's final HICP release a few days prior was the alarming news from the various metrics which we calculate and track each month to better gauge underlying inflation trends and to inform our monetary policy forecasts. The main aspects to highlight include:

• Trimmed mean inflation (TMI) — which strips out the items with the largest price swings each month — jumped to a new record high. This measure serves as a guide to how broad-based movements in inflation have been.
• Our 'super core' inflation rate — which includes only the HICP items that are estimated to be sensitive to changes in the eurozone's output gap — also jumped. This measure of inflation is influenced most by services prices, which tend to be more domestically driven.
• The proportion of HICP items recording inflation rates above the ECB's 2% target rose to a new high of 89%. This is a metric that we know the ECB is monitoring and which has contributed to its recent aggressive pace of policy rate hikes.

Outlook for inflation

Energy inflation will plunge again in March given the record 12% m/m surge in prices a year previously following Russia's invasion of Ukraine.

With base effects also likely to push food inflation down in March, the headline inflation rate will tumble.

But lower headline inflation will continue to play second fiddle to the continued climb of core inflation when it comes to monetary policy decisions.

Tighter for longer

Based on recent ECB commentary, the downward trend in headline inflation is of secondary importance to continued concerns over underlying price pressures.

The 50-basis-point (bp) rate hikes 'pre-announced' by the ECB remain the most likely outcome at the next policy meeting on March 16. That said, 75-bp hikes cannot be ruled out given the latest news on core inflation and the resilience of labor market conditions (employment growth having unexpectedly accelerated in Q4 2022).

Assuming the expected 50-bp hikes in March are delivered, our current judgment is that the most likely scenario is now another round of 50-bp increases in May, followed by a shift down to 25bp in June.

Sticky core inflation implies an increasing risk of the ECB overdoing the tightening. The eurozone may have (just) avoided an energy-driven recession over the winter but the risk of a policy-induced recession further down the line is rising.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.