The ECB’s ongoing concern: The stickier-than-expected core inflation

by | Mar 7, 2023


By Rufaro Chiriseri, Head of Fixed Income for the British Isles at RBC Wealth Management

The euro area’s uncomfortably elevated inflation signals that the European Central Bank (ECB) is unlikely to back off further interest rate hikes over the next few policy meetings. According to the February ECB meeting minutes, officials determined it was “much too early to declare victory” on inflation and the recent data affirms the Governing Council’s assessment. Last week, February inflation data in France and Spain came in above the consensus forecasts and German inflation also surprised on the upside. Inflation in the euro area’s largest economy accelerated to 9.3% y/y.

While headline euro area inflation declined in February, the central bank is more concerned about the stickier-than-expected core inflation. The core reading, which excludes the more volatile food and energy prices, accelerated to a record of 5.6% y/y and exceeded economists’ consensus estimate of 5.3% y/y. This upward surprise to core inflation and the ECB meeting minutes stating that “concerns of overtightening were premature” leads us to think that the terminal policy rate could reach 3.5%, but below market expectations of 3.9%. The biggest question, in our view, will be, how quickly does inflation need to decelerate to bring comfort to the Governing Council? Ultimately, we think it will be a compromise between the policy doves and hawks after the May meeting and several data releases. At that point, the council may shift to a meeting-by-meeting approach.

In the UK, Bank of England Chief Economist Huw Pill sounded a little more hawkish than his fellow policy committee member Governor Andrew Bailey. Pill stated that the economy is proving “slightly stronger than expected” and wage growth has been stickier than anticipated. In comparison, Bailey suggested caution “against suggesting either that we are done with increasing Bank Rate, or that we will inevitably need to do more.” The markets now expect the Bank Rate to reach a peak of 4.7%, and the realisation that inflation is still persistent has led to another week of underperformance for bond markets globally. Gilt yields rose across the yield curve with 10-year Gilt yields leading—rising about 30 basis points from a week ago to 3.88%.

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