Source: Tradingview
Last week’s print shows core inflation is still very sticky, and not only reinforces the likelihood of a 50-basis point rate hike in March, but also paves the way for a similar move in May. Investors now see the ECB’s 2.5% deposit rate rising by a combined 100-basis points in March and May, then to around 4.1% by the end of the year.
The issue is that the persistently high levels of underlying inflation, which is a leading indicator on the durability of price growth, suggests that achieving the ECB’s target of 2% may be a prolonged process.
Of particular concern is the significant acceleration in price growth for services to 4.8% from 4.4%, which is the largest component of core inflation. This sector is highly susceptible to changes in wages, and the uptick in price growth implies an increase in labour costs.
The unemployment rate is holding at 6.7%, a level slightly above a record low, pointing to a tight labour market that could result in nominal wage growth exceeding 5% this year. This situation creates the potential for wage increases that could further inflate service prices and keep the aggregate inflation levels elevated.
Given these factors, the ECB may have to consider implementing another 50-basis points rate hike in May to address these concerns. Apart from raising interest rates, the ECB is fighting inflation by mopping up some of the 7-trillion-euros worth of liquidity poured into the financial system over the past decade of money-printing.
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