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It’s time for the monthly preliminary inflation numbers from Europe again and we are yet to fear a YoY re-acceleration in European numbers. Base effects are massive over the course of September and October, but there are signs of a cyclical pick-up in EUR-flation from late Q4 and onwards as well.
Conclusions up front:
- Energy-inflation will bottom in November in Europe and goods inflation will likely follow
- Services inflation will likely start to look very weak already this month, leaving a surprise in EUR-flation likely. We see material risks on the low side of the 0.5% MoM consensus.
- The probability of the ECB getting back to target is much higher than the Fed
- The EUR will remain in trouble due to energy, while EUR bonds do not offer a decent risk/reward yet. Pay Mar-24 versus Receiving Mar-25 or be short EUR.
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Let’s have a look at the details.
Another couple of months of easy disinflation
European inflation is still broad-based outside of electricity and heating. Transportation services, recreation, culture and Restaurants & Hotels have remained hot over the summer (also in YoY terms) and the big test for the inflation momentum is now whether the discretionary spending and services inflation will wane at the same time over the course of the autumn. We certainly lean that way given the weakness seen in Europe.
Chart 1: European inflation heat-map (in YoY terms)
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European dis-inflation will happen automatically in year-over-year terms through September and October as the monthly increases in the Euro-area wide HICP estimate printed at 1.2% and 1.5%, respectively in September and October last year.
With a couple of soft prints, we may get very close to or even below the annual target inflation by November as a consequence.
The seasonality (remember that HICP series are not adjusted for seasonality) is typically not as benign as in October 0.3% as usually on the month due to seasonals.
Chart 2: Seasonality a positive factor for inflation in Oct
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We will get close to the target by November, but then base effects will likely send annual inflation higher for a few months.
We need monthly inflation prints at 0% or below to get to target or below this year. The scenario was not ruled out until we started seeing higher retail energy prices again over the course of August and September.
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Trends will remain benign enough for the ECB to conclude that pausing hikes is warranted, even if we jump back above 3.5% in January as seems like a likely base case now (See the 0.2% MoM path in Chart 3)
Chart 3: Annual inflation given various paths for MoM inflation
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European energy-flation will start to re-accelerate due to three factors. 1) Retail prices on gasoline are on the rise again, but due to larger taxes on Gasoline in Europe compared to the US, it will look less violent in headline inflation. 2) Climate credits are turning into a net “positive impulse” for Energy-flation again, which goes hand in hand with 3) A slight tick-up in industrial activity and demand for energy resources such as natural gas.
Chart 4: Energy-flation will start rising again from November and onwards
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The IFO price survey (new monthly details revealed tomorrow) still looks promising and the overall price expectations are now back in line with “normalized” levels of inflation around or below 2%.
This is in sharp contrast to the US where similar price surveys have re-accelerated over the past 2-3 months. We expect to see early signs of a re-acceleration of overall prices in the details released from the IFO Institute tomorrow morning.
Chart 5: IFO Price Survey pointing to normal inflation in Europe within 6 months
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The elevated services inflation looks set to drop markedly from a momentum perspective. We saw how the UK CPI surprised materially on the low side of expectations due to a complete halt to price hikes in Services.
We see similar dynamics in both 1) activity data in Services, 2) Hiring intentions and 3) Price surveys in the Eurozone, leaving the Service-inflation with the best odds of surprising clearly on the low side in the September numbers from Eurostat.
Chart 6: Services inflation is likely to wane markedly in Europe
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In the details from the IFO Institute tomorrow, we will be watching the price expectations in various sectors carefully.
Expectations in Chemicals and Food have risen over the past 1-2 months and we expect to see a continued rebound in cyclically sensitive price categories. Meanwhile, we expect broader service price expectations to continue to wane fast from here.
Chart 7: Services versus Manufacturing/Goods Inflation
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Overall, there are good odds of betting on lower than expected EUR-flation in September and October, while the tide turns again from November and onwards in the prices of the cyclical goods.
The Spanish inflation canary in the coal mine is reaccelerating from low levels, which is not a good sign for EUR-flation from November 2023 and until January 2024.
Chart 8: Spain versus Germany
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As the ECB is likely to pause amidst all of this, we don’t see a strong risk/reward in betting on lower interest rates in EUR (yet).
The ECB members went on parade yesterday with warnings that another round of subsidies aimed at mitigating the effects of higher energy prices would prove catastrophic for the combat against inflation, but they also emphasize that they hope that they have hiked for the last time in this cycle.
The best nitty/gritty value is likely found in paying Jan or Mar-24 contracts in ESTR due to a temporary spike in inflation from November and onwards. Else, we see a weak EUR as the main release valve of the cocktail of softness in Services inflation paired with re-acceleration in Energy-flation. A spread between paying Mar-24 versus Receiving Mar-25 looks interesting on a cocktail of recessionary growth and sticky energy-flation.
Damned if you do, damned if you don’t for the ECB.
Chart 9: ECB Fwd Pricing
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