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A big drop in eurozone inflation offers little help for the ECB. From Reuters

A big drop in eurozone inflation offers little help for the ECB. From Reuters

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©Reuters. FILE PHOTO: The European Central Bank (ECB) building is seen in the fog before the monthly press conference following the ECB’s monetary policy meeting in Frankfurt, Germany, December 15, 2022. REUTERS/Wolfgang Rattay

By Balazs Koranyi and Jan Strupczewski

FRANKFURT/BRUSSELS (Reuters) – Euro-zone inflation has slumped over the past month, but underlying price pressures are still mounting and economic growth indicators are surprisingly benign, suggesting the European Central Bank will hike interest rates further in the coming months .

The ECB has raised borrowing costs faster than ever since July in its fight against a historic rise in prices. It has promised a number of further steps this year to curb inflation, which its own economists say will remain above its 2% target well into 2025.

Consumer price growth in the 19 countries that use the euro slowed to 9.2% in December from 10.1% a month earlier, Eurostat data showed on Friday – well below a Reuters poll forecast of 9.7%, the decrease being due to lower energy prices.

The eurozone has since expanded to 20 nations, with Croatia joining on January 1st.

But the headline masked a more malicious trend, with all key components of core inflation accelerating.

Excluding volatile food and energy prices, inflation rose to 6.9% from 6.6%, while an even narrower metric that also excludes alcohol and tobacco rose to 5.2% from 5%.

Non-energy services and non-energy industrials inflation, both closely monitored by the ECB to gauge the durability of price growth, accelerated, raising concerns that inflation is proving to be more stubborn than expected.

“Rising core inflation means the European Central Bank won’t deviate much from the hawkish stance it embarked on late last year,” said ING economist Bert Colijn.

MILD RECESSION

A number of other indicators are also suggesting that the bloc’s winter recession will be milder than expected, leaving the ECB with more work to tame prices.

A key indicator of economic sentiment improved more-than-expected, while retail sales also showed surprising resilience.

Exceptionally mild weather, implying lower consumption of expensive energy, will also help by supporting household purchasing power and preserving corporate margins.

But that could make life difficult for the ECB.

The recession was expected to push up unemployment and, of course, dampen price pressures. But employment, already at a record high, is actually rising, not falling.

Fiscal support for households is also proving more generous than hoped, and this excessive spending increases purchasing power and counteracts the ECB’s tightening policy.

“The delayed pass-through of high production costs and a still strong labor market will support core inflation,” said Oxford Economics’ Riccardo Marcelli Fabiani.

“With core inflation at record levels and likely to remain elevated in the coming months, we expect the ECB to make two 50bps hikes in February and March, before pausing amid slowing inflation and muted economic trends.”

Although inflation could pick up again in January, it has probably peaked and the ECB’s focus will shift to how quickly it will fall back.

Markets and surveys are beginning to discount the possibility that price growth will remain above 2% for longer, and even the ECB’s own forecasts, which have proved overly optimistic over the past two years, do not see the bank reaching its target anytime soon reached in 2025.

The problem is that the longer inflation stays high, the harder it is to contain as firms begin to adjust pricing and wage policies and continue price pressures.

That’s why the ECB has hiked interest rates by a total of 2.5 percentage points over the past year – a mirror image of its global peers, albeit a little later – and promised big hikes in both February and March, bringing the deposit rate to around 3% must.

“We expect the deposit rate to come in at 3.25% in the spring, where it’s likely to stay for some time,” said Commerzbank’s Ralph Solveen (ETR:).

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