A ‘sticky’ problem
|We forecast euro area HICP inflation to average 7.2% in 2023 and 2.9% in 2024. Core inflation will return to the ECB’s target only in H2 24. In light of ongoing cost-push inflation, we think markets are underestimating the ‘stickiness’ in euro inflation.
On the face of it, the November flash HICP figures brought a welcome decline in headline inflation from 10.6% to 10.0%. However, we think the evidence for a similar peak in underlying inflation pressures is less clear-cut and ‘stickily’ high core inflation could remain a concern for ECB for some time yet.
Firms continue to pass-on higher input costs to consumers and in spite of an approaching recession (see Big Picture Euro area - Double dip recession, 28 November), we expect this process of cost-push inflation to extend into 2023, keeping price pressures elevated for longer. Despite the moderation in natural gas and electricity prices, delayed pass-through to household bills will mean energy price inflation will abate only gradually, while the downside risk from price caps seems limited. Core inflation will prove sticky in our view, due to second round effects from higher energy, material, but also labour costs. Our forecasts are above current market pricing and show headline inflation returning to the ECB’s target not before the end of 2024, with the green transition and higher than expected wage growth still presenting upside risks.
Energy: The joker
With no end of the Russian-Ukraine war in sight, energy price developments will likely stay volatile, rendering any inflation predictions highly uncertain. While wholesale gas and electricity prices have come somewhat off their previous peaks, the latest energy price shock has yet to fully filter through to consumer prices. The pass-through from wholesale to consumer gas prices is usually only around 13% and can take up to 12 months to materialize. For electricity prices, the effect is even lower, as historically only about 4% of a change in wholesale gas prices is passed on to consumers’ electricity prices within 12 months (and only 25% of the effect materializes within the first month). Cross-country heterogeneity is strong and regulatory frameworks and government interventions differ significantly across euro area countries. Even within countries, multiple contracting practices co-exist (f.ex. between different German states), with some households and firms still holding longer-term contracts that lock in prices for several months.
This implies that the rise in wholesale prices observed in 2022 is set to exert continued upward pressure on retail gas and electricity prices throughout next year as well. We think that larger price increases will occur especially with the turn of the year, as many energy providers will seek contractual price increases in light of the new reality in energy markets. We expect HICP energy inflation to peak at 38% in Q4 22 and head gradually lower as negative base effects from the stabilization in oil prices will weigh on fuels for personal transport. The German gas and electricity price brake that is taking effect in March 2023 should also contribute to the slowdown in energy inflation, but the impact from any future EU gas price cap seems limited (see also Euro inflation notes - Energy variations, 10 October). On the other hand, delayed pass-through from higher gas and electricity prices due to long-term contracts will keep a hand under energy inflation in 2023 in our view. France, which froze gas bills in October 2021 and capped electricity price increases at 4% in 2022, will also allow bigger price rises of up to 15% from January 2023.
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