Confirmation from the ECB: “High inflation until 2025”. And realism returns to stock exchanges

Inflation in the eurozone will also remain above 2% in 2025. That is, for another three full years. That is, another 1,096 days (since next year will be a leap year). Explaining that the general level of consumer prices will be above the target of the European Central Bank (ECB), which is set at 2 percentage points, is the latest Survey of Professional Forecasters (SPF), released today by Frankfurt. The inflation rate will be at 5.9% for 2023 (an increase of one decimal place compared to the previous estimate), at 2.7% in 2024 (up 0.3%) and will remain at 2.1% at the end of 2025 Barring positive surprises. The persistence of the general price level beyond the ECB’s target is, at least to date, a certainty. And it confirms Christine Lagarde’s concerns about core inflation, which needs to be tackled sharply.

The good news is the achievement of the peak of the general index. The negative is that Core inflation, ie excluding energy and fresh food, will remain at levels never experienced in recent decades. The transfer of price increases from the energy sector to the manufacturing sector and therefore to the services sector is now complete, as recalled by more than one source from the European Central Bank. And this is what worries Frankfurt. The upward revisions contained in the (SPF) “reflect the corresponding changes in inflation expectations excluding energy, food, alcohol and tobacco (HICPX index, ed.)”. According to respondents, “these changes mainly reflect a combination of recent data findings, even stronger and wider-than-expected indirect effects of energy price developments, as well as higher expected wage growth.” Expectations for 2025 , not recorded in the previous round, stood at 2.1%.The positive news, by virtue of the peak reached, is that “longer-term inflation expectations (for 2027) have been revised downwards by 0.1 percentage points to 2.1% on average”.

On the macroeconomic front, GDP growth expectations according to the ECB survey “remained broadly unchanged with a positive “contribution” from stronger-than-expected economic activity in the second half of 2022 impacting 2023, but offset by slightly weaker expectations for 2024 than previously reported.” Longer-term expectations also remained unchanged at +1.4 per cent. Furthermore, as explained in the SPF, expectations on the unemployment rate have instead been revised downwards “for all horizons between 0.1 and 0.2 percentage points. After an expected increase to 7.0% in 2023 (the unemployment rate was at 6.5% in November 2022), the unemployment rate is expected to gradually decline to 6.4% by 2027.

Yesterday’s market rally may have been too euphoric, according to several observers. Like Mahmood Pradhan, head of global macroeconomic research at Amundi, who points out that “the rally inspired by the ECB risks being excessive”. Specifically, he says “the ECB has sent a different message than the rather aggressive tone of December. On this occasion, the central bank spoke of a more balanced situation, both in terms of growth and inflation, while reiterating that it will stay on course to ensure a return of inflation to the 2 percent target”. Which will still be far away for a long time, even if according to the new course of the ECB which has been going on for over a year, a temporary variation above or below 2 percent is tolerable. According to Pradhan, “the market expects the ECB to halt hikes after making another 50 basis point hike in March.” The result is that Italian BTPs have outperformed German Bunds, posting a contraction in the rate of return greater than that of Mario Draghi’s “Whatever it takes” of July 2012. “The size of the gains seems a bit extreme to us given the uncertainty that still persists. For example, we still don’t know the full impact of China’s reopening and core inflation remains high in the eurozone,” underlines the Amundi economist.

That there was a misalignment between the Frankfurt communications and the interpretation of the financial markets is evident from the fact that today’s response was very divergent from yesterday’s. The tension on government bonds has returned, with the yield on Italian ten-year BTPs again above 4%. The differential between German 10-year BTPs and Bunds today rose to 183.7 points, with the Italian annual yield up 13.2 points to 4.022%. The yield on German Bunds rose 11.8 points to 2.18%, while US Treasuries gained 10.6 points to 3.49%. The trading venues were also very weak, starting with Milan, which lost 1.2% in mid-afternoon, while Frankfurt fell by 0.77%. After the euphoria, realism has returned to dominate.