Eurozone Inflation Slowdown Pauses... Will Tightening Intensify?

As the pace of price declines in the Eurozone (20 countries using the euro) slows down, pressure for additional tightening by the European Central Bank (ECB) is increasing. This is because the slowdown in the inflation rate in February fell short of expectations, and inflation in key sectors such as food and services excluding energy continues to rise. The market expects the ECB to maintain the current tightening intensity at least until the second quarter of this year.

On the 2nd (local time), Eurostat, the statistical agency of the European Union (EU), announced that the Eurozone consumer price index rose 8.5% year-on-year in February, exceeding Wall Street’s forecast of 8.2%. Although the slowdown trend was maintained for the fourth consecutive month, the increase narrowed by only 0.1 percentage points compared to January (8.6%).

Prices of goods and services excluding energy continued to rise. Among sectors, the food price inflation rate jumped 15% year-on-year, showing the highest increase, and the rise also expanded compared to the previous month (14.1%). The inflation rates for industrial products and services were 6.8% and 4.8%, respectively, up 0.1 percentage points and 0.4 percentage points from the previous month. The energy price inflation rate was the only one to stabilize, falling 5.2 percentage points from the previous month (18.9%) to 13.7%.

[Image source=Reuters Yonhap News]

Economic analysts say that with the slowdown in inflation deceleration, it is too early to be reassured about prices, and the current tightening measures are expected to continue at least until the second quarter of this year. The major U.S. investment bank Goldman Sachs expects the ECB to implement a big rate hike at its May meeting as well. It initially forecast a 0.25 percentage point increase but has since revised it upward.

Melanie Debono, an analyst at financial information firm Pantheon Macroeconomics, said, "Based on the data released today, ECB hawks will argue that the 0.5 percentage point rate hike pace should continue through the second quarter." She added, "The fact that core inflation in the Eurozone remains at a relatively high level while the unemployment rate is at a near-record low of 6.7% will serve as a background for hawks to raise their voices."

Since entering tightening mode in July last year, the ECB has raised its key interest rate to 3.0%, and after last month, it has announced an additional 0.5 percentage point hike this month, declaring the maintenance of the big step. At last month’s monetary policy meeting, the ECB had warned of further rate hikes, stating that "it is still too early to declare victory in the fight against inflation."

ECB President Christine Lagarde emphasized at last month’s meeting, "To bring inflation back to the target of 2%, we will maintain a substantial rate hike stance at a steady pace if necessary." However, she expected the inflation rate to slow down in March.

With a big step hike expected at the ECB’s monetary policy meeting on the 16th, investors are closely watching how high the ECB’s terminal rate will go. The market expects the terminal rate to reach 4.0%, which is 0.5 percentage points higher than the early-year forecast. However, since the 20-country committee members with different economic conditions need to reach a certain consensus, it may be difficult for the ECB to be more hawkish than the market expects, CNBC, a U.S. financial media outlet, cited an investor memo from Berenberg Bank in its outlook.