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Eurozone inflation beats expectations, what will ECB do?

by January 6, 2023
by January 6, 2023 0 comment
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I wrote on Wednesday about how optimism had jumped in the wake of softer-than-expected inflation numbers out of France. Markets moved upward as investors turned their eyes towards today, when the all-important eurozone inflation numbers were to be announced, hoping that the positive French reading might signal that today would also bring kinder news.

Eurozone inflation better than expected

They have got their wish. Eurozone inflation has come in at 9.2%, south of expectations of 9.5%. The previous month’s reading was 10.1%, meaning a healthy 90 bps drop and a move back into the single digits.

Core inflation remains high

But hold off on popping the champagne because it is not all good news.

Core inflation, which strips out the more volatile items of food and energy, rose to a new high of 5.2%. This implies that falling gas prices are pulling down the headline number (9.2%), yet the underlying causes of the cost-of-living crisis remain present, as seen in the rising core number.

Traditionally, it is this core number that policymakers pay attention to. Monetary policy is geared towards this metric as food and energy are too volatile and move based off too many variables to be within the remit of central banks’ control, which has been glaringly obvious this past year with the invasion of Ukraine causing energy prices to go bananas.

Looking at the below chart paints a vastly different picture, showing the upward trend remains.

What will the ECB do?

With core inflation still on the up and well north of the 2% target outlined by the ECB, a further programme of interest rate tightening is needed. Rates are currently at 2% – well below what is being seen on the other side of the Atlantic with the Federal Reserve having hiked past 4% – and analysts had before this week been anticipating a further rise up towards 3.5%.

With four hikes being implemented by the ECB last year, the eurozone is already staring a recession right in the face. The area has come under intense pressure in the wake of the Russian invasion of Ukraine, with both an energy crisis and a cost-of-living crisis gripping countries across the bloc.

The Stoxx 600, a stock market index which captures 90% of market capitalisation across 17 nations, peeled back close to 13% last year. Looking at selected individual nations, the German DAX fell over 12%, French CAC 40 dropped 9.5% and the Spanish IBEX 35 gave up 5.7%.

The news comes off the back of ECB President Christine Lagarde’s hawkish tone in December:

“We’re not pivoting, we’re not wavering, we are showing determination.”

Stock markets tread cautiously

In the immediate aftermath of the news, European stocks were cautious. The Stoxx 600 was flat, appreciating the drop in the headline number but refusing to move upward given the stubborn core figure.

The index is up 2.5% thus far this year, with expectations seemingly priced in that inflation would be worse than what has transpired. The index had banked three consecutive days of positive moves earlier this week.

 Eyes will now turn to the States. US non-farm payrolls are expected out today, before next week gives the all-important CPI number.

2022 was summed up by stock markets moving off the back of central bank decisions on interest rate policy, as policymakers scrambled to get inflation under control. 2023 has commenced the same way. There is a long way to go yet, and it appears this will be the case for the first half of the year at least.

The post Eurozone inflation beats expectations, what will ECB do? appeared first on Invezz.

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