Underlying inflation in the euro zone has probably peaked, even though its exact level remains difficult to determine, according to the European Central Bank.
The recent easing is mainly driven by non-energy industrial goods, the ECB wrote in a pre-release of its economic bulletin published on Friday, adding that a decline for services appears to have started too.
At the same time, it said that domestic price pressures are becoming more prominent, echoing the Governing Council’s conclusions last week.
Policymakers lifted interest rates for a ninth time to 3.75 per cent then, and said inflation is still expected to stay too high for too long. President Christine Lagarde promised a deeper analysis of underlying trends in September that will inform a decision on whether to hike once more or to pause.
The dashboard officials will consult includes “permanent exclusion-based measures” that strip out certain more volatile items, “temporary exclusion-based measures” that disregard some volatile dynamics, and “model-based measures” that rely on economic relations to identify stickiness.
“Underlying inflation measures should capture more persistent and generalised developments across prices, abstracting from volatile or idiosyncratic relative price movements, and thereby provide an informative signal about where headline inflation will settle in the medium term,” the ECB wrote.
It has said that any future policy decisions will depend on incoming economic and financial data, underlying inflation dynamics and the strength of policy transmission.
While outgoing executive board member Fabio Panetta said on Thursday that underlying inflation pressures were moderating, he offered a different analysis. Empirical evidence suggests so-called core price growth “is a lagging – not a leading – indicator,” he said.
“Core inflation today does not tell us much about where headline inflation will settle in the medium term,” he said in Milan. “Just as higher energy prices seeped through the economy on the way up, they will also eventually do so on the way down.”
Chief economist Philip Lane defended the ECB’s approach in an ECB podcast published on Friday.
“Conceptually we are very focused on underlying inflation, but it’s more work than normal to work out where that is,” he said, expressing confidence that price pressures in the euro zone “should come down quite a lot later this year”.
In its bulletin, the ECB conceded that the forecasting performance of its dashboard gauges varies, and said they stood between 2.9 per cent and 6.9 per cent in June.
It identified domestic inflation, PCCI – Persistent and Common Component of Inflation – and HICP (Harmonised Index of Consumer Prices), which excludes energy, food, travel-related items and clothing and footwear, as generally doing better than others.
“Underlying inflation likely peaked in the first half of 2023,” and although most measures show signs of easing, it “remains high overall,” the ECB wrote. The observed trend is “broadly in line” with its June projections.
Sticky inflation remains a conundrum for central banks around the world as economies struggle to digest the ripple effects of pandemic-era supply shocks and the energy price surge that followed Russia’s invasion of Ukraine.
In the euro zone, consumer prices rose 5.3 per cent last month from a year earlier, half the pace of the peak in 2022. Core inflation remained at 5.5 per cent, and both aren’t expected to reach 2 per cent by the end of 2025.
The ECB recommends that tracking underlying inflation should be complemented with “close monitoring of the factors that are likely to determine domestic price pressures over the medium term, notably the incoming data on wages, profits and inflation expectations.”
(Updates with comments from ECB’s Lane starting in 10th paragraph)
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