ECB to note marked deterioration in outlook for inflation and growth

Chris Scicluna
Emily Nicol

ECB to acknowledge marked deterioration in the outlook for inflation and growth
All eyes today should be on the ECB’s monetary policy meeting, when the Governing Council will have to gauge the impact of events in Ukraine on the euro area economic outlook and determine how it should respond. Before the Russian invasion, the Council had looked set to agree a significantly faster reduction in its net asset purchases over the coming quarters to make room for a rate hike by year-end. And since then, of course, the near-term inflation outlook has got markedly worse, due to the sharp rise in prices of energy and commodities, as well as the prospect of a marked tightening of supply bottlenecks. Indeed, inflation looks set to peak firmly above 7% over the near term, and average more than 6% this year. But while that might suggest a greater urgency to phase out net asset purchases, economic growth momentum is bound to be hit hard by the erosion of real household incomes, much higher business costs, weaker exports, and a marked loss of confidence, as well as the additional supply-side restraints. Indeed, were it not for ongoing economic reopening from the pandemic and the accumulation of a buffer of household savings throughout the pandemic, recession would be odds-on. As a result, and in light of the continued weakness of wage growth, once energy prices eventually stabilise, inflation could well fall back below the ECB’s 2% target and stay there.

Extreme uncertainty, and lessons from the past, suggest that ECB should err on the side of caution today
Crucially, of course, the duration and precise path of the conflict is impossible to predict, as is the effect of those events on energy, commodity and financial markets. And that means that the path of euro area GDP and inflation is extremely uncertain too, with a wide range of possibilities. So, rather than expressing confidence in a single baseline of macroeconomic projections, we expect the ECB to set out a range of plausible scenarios. And while under certain scenarios, inflation will be expected to remain above the 2%Y/Y target over the horizon, under the most severe scenario inflation would fall back below target and remain there through to the end of the 2024.

Given the uncertainty, and the ECB’s ignominious track record of policy errors at times of crisis, the Governing Council should therefore today err on the side of caution. While it is certainly possible that it will decide to speed up the pace of reduction in its net purchases over the coming quarter, on balance, for the time being we expect it to leave unchanged its plan to reduce its monthly net asset purchases to €40bn in Q2 and €30bn in Q3, while maintaining ‘optionality’ for a faster pace of normalisation in due course if necessary. At the same time new initiatives (e.g. related to liquidity provision, swaps with neighbouring central banks, or even an increased share of net purchases of EU agency securities) are possible over coming months as events unfold. And mindful of the recent steady downtrend in the euro, we suspect that the Governing Council’s statement will pay lip-service to being ready to respond to upside risks to inflation posed by exchange rate developments. However, in our opinion, forex intervention would only come into play in extreme circumstances and in a coordinated manner with other G7 central banks.

EU summit this evening to discuss principle of new common bond issuance to fund infrastructure and defence initiatives, but debate on detailed options to wait for another day
Beyond monetary policy, the EU’s informal summit at Versailles will also start on Thursday, with plans to increase energy independence from Russia, and possible new EU borrowing to help fund the required infrastructure as well as common defence initiatives – reports of which today contributed to a sell-off of Bunds but significant narrowing of BTP spreads – to be discussed. Data-wise, the calendar for the coming couple of days is free of top-tier releases, although Italian IP numbers for January are expected to report a modest decline in output at the start of the year.

US CPI inflation likely to rise to a new 40-year high
Today’s data highlight will be the US CPI report for February. Energy prices accelerated last month and food prices remained under upwards pressure. So Daiwa America’s Mike Moran expects consumer prices to have risen 0.7%M/M, a touch below the Bloomberg consensus, but just above the average for the past year. If Mike’s right, the annual inflation rate will jump to 7.8%Y/Y, the highest for more than four decades. And against the backdrop of strong demand, rising residential rents and supply-side disruptions, this release is likely to confirm a further broadening of price pressures – indeed, core prices are forecast to have risen 0.5%M/M, to be almost 6½% higher than a year earlier. Today will also bring weekly jobless claims numbers, Federal monthly budget statement for February and the Fed’s flow of funds numbers for Q4.

Japanese producer prices boosted above expectations by higher energy costs
In keeping with the recent trend, there was an upwards surprise to today’s Japanese goods PPI inflation release. In particular, producer prices rose 0.8%M/M in February to leave them 9.3% higher than a year earlier, the strongest annual rate for four decades. Price pressures were again most significant in petroleum, coal and natural gas (up 3.0%M/M, 34.2%Y/Y), with imported prices of such products exacerbated by the weaker yen up a still-staggering 84.8%Y/Y (albeit down from November’s peak of 132.7%Y/Y). Prices of lumber and wood products were up a lofty 58.0%Y/Y, while iron and steel and nonferrous metals prices were up by around a quarter from last year. As such, producer raw material prices were up by more than 3%M/M, 50.9%Y/Y. But there was still limited evidence of these higher input burdens being passed significantly along the supply chain to consumers. Indeed, final producer consumer goods prices were up just 0.1%M/M in February to leave the annual rate at 4.1%Y//Y, down 0.2ppt from January and 1ppt lower than November’s peak.

UK residential property prices remain under upwards pressure on supply-demand imbalances
The RICS residential market survey of chartered surveyors suggested that the UK housing market continued last month to see solid demand and rising prices despite the recent dip in consumer confidence, declining disposable incomes and the prospect of further hikes in Bank Rate over coming months. Surveyors suggested that the number of new buyer enquiries rose in February to the highest since last May, with a sizeable jump in London. But with new vendor instructions continuing to fall, and the stock of properties on surveyors’ books at near-record lows, the dearth of supply placed further upwards pressure on house prices – indeed, the share of surveyors reporting higher prices rose 5pts to 79%, the highest since June, with the equivalent in London (60%) the highest for almost eight years. And not least reflecting the persisting supply-demand imbalance, responding surveyors remained upbeat about prospects for the housing market over the year ahead, with price expectations rising to a new record high.

UK starting salaries rise sharply on marked labour market tightness
The KPMG/REC UK Report on Jobs suggested that ongoing supply constraints in the labour market continued to put upwards pressure on starting salaries. Recruitment consultancies signalled a further increase in hiring activity in February as new business picked up and vacancies rose, although the pace of permanent job placements was the softest for eleven months. But this principally reflected a limited pool of candidates, due in part to ongoing pandemic-related uncertainty and fewer foreign applicants. And with competition for workers intensifying, pay pressures continued to rise, with the survey suggesting that permanent starter salaries were rising at the second-sharpest pace since the series began in 1997.

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