Euro area reflation story ending – Danske Bank

Senior Analyst, Pernille Bomholdt Henneberg at Danske Bank, explains that the rise in inflation to the ECB’s 2.0% target for the first time since 2013 implies that market expectations have turned in favour of expecting a more hawkish stance from the ECB (a 50% probability of a 10bp deposit rate hike from the ECB is priced in for the end of this year).

Key Quotes

“However, the rise in inflation has so far been driven by volatile energy and unprocessed food price inflation, while the underlying price pressure reflected in core inflation remains subdued. Consistent with weak underlying price pressure, the market is pricing in lower inflation in coming months (down at 0.8% in January 2018), which in our view is in sharp contrast with the expectations of a policy rate hike this year.” 

“We expect the ECB to decide on whether to start tapering its QE purchases at the meeting on 7 September. Hence, we consider the inflation figures released ahead of this meeting.”

“Our conclusion is that the rise in inflation is not a sustained adjustment towards the 2% target, as core inflation is set to print below 1.0% for the next six months, except for one month where it will be lifted by the timing of Easter. The most important reason why core inflation should stay modest is our expectation of subdued wage pressure due to slack in the labour market particularly in the periphery countries but also continued modest wage growth in Germany.” 

“Based on this, we still expect the ECB to announce a third QE extension in September and most likely continue buying assets of EUR60bn per month, as its focus will remain on the underlying price pressure. However, the ECB might continue to remove some of its dovish communications from the introductory statement prior to this but, in our view, this does not mean it will start hiking policy rates or tapering QE towards zero.”