Eurozone inflation and growth persistence will fade in coming months

We analyse both pieces of data and in our judgement today’s data builds on other data that shows that ECB hikes are just starting to have an impact on the economy and that a further economic slowdown is on the cards. Our base scenario sees the ECB deposit rate being raised once again by 50bp in March to reach a peak of 3.0%. While the risks to our view are clearly tilted to the upside, we continue to think that an economic downturn and falling inflation will see the ECB pivoting earlier than it is currently signalling and markets are now pricing.

Inflation lifted by accelerating food price inflation

The first big eurozone countries have published inflation data for February. They came in higher than expected. In France the headline rate increased from 6.0% in January to 6.2% in February, whereas stabilisation was expected. In Spain headline inflation rose from 5.9% to 6.1%, whereas a decline to 5.7% was expected. Not a lot of details have been published, but it seems that core inflation increased a touch. France did not report core inflation but the components of the CPI that were published revealed that services price inflation increased by 0.3 percentage points and good price inflation ticked higher by 0.1 percentage points. Spain reported a rise in core inflation to 7.7%, up from 7.4%. But, in contrast to the Eurostat data for the eurozone as a whole, Spain only excludes fresh food from the headline rate to calculate the core and not processed food, which is excluded by Eurostat. It seems that the rise in core inflation in Spain was largely due to higher processed food price inflation. Summing up, the rise in headline inflation in France and Spain probably was mainly due to the fact that a further acceleration in food price inflation more than outweighed a further decline in energy price inflation. Indeed, France reported a rise in total food inflation from 13.3% to 14.5% and a decline in energy inflation from 16.3% to 14.0%.

Total eurozone inflation will be published on Thursday 2 March. The consensus forecast is that headline inflation falls from 8.6% in January to 8.3% in February. But the data from France and Spain suggest that eurozone inflation could actually rise to around 8.8% on the back of the jump in food price inflation. The consensus forecast is that core inflation stabilises at 5.3%, which still seems likely, although the risks seem to be tilted towards a small rise in core inflation. Looking further forward, we continue to see both headline and core inflation falling rapidly later in the year on the back of the decline in wholesale energy and food prices as well as dissipating supply chain bottlenecks.

Monetary developments in the eurozone deteriorating rapidly

Recent ECB data for monetary aggregates and their main counterparts shows that monetary developments in the eurozone are deteriorating rapidly on the back of interest rate hikes by the central bank and a cooling economy. To begin with, the annual growth rate of the nominal narrow monetary aggregate M1, comprising currency in circulation and overnight deposits, decreased to -0.7% in January from 0.6% in December, staging its first decline since the start of the series in January 1971. During past cyclical swings, real M1 growth (nominal M1 corrected for inflation) was a good leading indicator for changes in GDP growth with a lag of about nine months (see the graph below). Considering that monetary developments as well as inflation currently are still impacted by supply and demand side disruptions during the pandemic and the war in Ukraine, the link between real M1 and GDP growth probably weakened. Nevertheless, the drop in nominal and real M1 growth does indicate that the economy is hit by the drop in M1 growth.

Furthermore, the counterparts of the broad monetary aggregate M3 show that annual growth in the parts that have the closest link to real economic developments, i.e. loans to the private sector slowed down noticeably as well. The annual growth rate of adjusted loans to the private sector (i.e. adjusted for loan sales, securitisation and notional cash pooling) decreased to 4.9% in January from 5.4% in December. The annual growth rate of adjusted loans to households decreased to 3.6% in January from 3.8% in December, while the annual growth rate of adjusted loans to non-financial corporations decreased to 6.1% in January from 6.3% in December. Although these annual growth rates still seem elevated, the monthly flow in adjusted loans to companies has declined in November and December 2022 and stabilised in January of this year. As a result, the three-month average flow fell to EUR -5.4bn in January, reaching its lowest level since November 2014 (excluding the swings in loan flows during the pandemic). If the current 3M average flow were to continue, the annual growth rate in adjusted loans to companies would become negative around the end of Q3.

The monthly flows in adjusted loans to households (largely mortgage loans) has slowed down noticeably as well, with the three-month average flow falling to EUR 11.5bn in January, compared to EUR25bn in January 2022. All told, monetary developments in the eurozone have clearly deteriorated, signalling economic weakness the coming quarters, which would be in line with our base case of modest contraction in GDP during most of this year.