Eurozone: Low inflation, but this is not enough for the European Central Bank

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It has decreased, but less than expected. February inflation was a minor disappointment for the ECB's “doves”. This, along with other data, seems to confirm the idea that the “last kilometer”, from here to the 2% target – which must be achieved in a sustainable way – is indeed a bumpy road, and will be traveled very slowly.

Inflation is higher than expected

The numbers speak clearly. The overall inflation rate reached 2.6%, compared to 2.8% in January, thanks above all to the decline in energy prices (-3.7%), which is above all an arithmetic effect: the monthly increase was sensitive, equivalent to 1.5%. Analysts had expected 2.5% annually. Core inflation, which excludes prices that cannot be controlled by monetary policy, was 3.1%, up from 3.3% in January. Expectations were 2.9 percent.

Surprise services

But what really surprised us was the services. The inflation rate in the sector fell to 3.9% on an annual basis, after remaining at 4% for three consecutive months. But in February alone, prices – which are the most stable and most closely linked to internal conditions in the economy – rose by 0.8%. It's a lot. If, hypothetically, inflation rose at the same rate not for one month, but for twelve months, annual inflation would rise to 9.6%.

Overheated sector

Not likely. However, if, as is more correct in calculation, services inflation continues in the last three months at the same rate as for twelve months, the services sub-index will return to 5.8 percent per annum at the end of the period. Annual quarterly data are highly variable and subject to strong seasonality: every year they reach a minimum in November, and then rise again. However, the current February rise is very rapid, very close to the pace of February 2023, and more intense than that of the distant past. It is therefore unclear how it might develop. It is true that the inflation rate in manufactured goods – generally exposed to international competition – is now 1.6%, up from 2%, but this is not the inflammation that monetary policy wants to treat now.

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The game of wages and profit margins

The ECB needs to see inflation truly under control, not just in aggregate data, but also in “core” data. President Christine Lagarde and Chief Economist Philip Lane invite us to consider – as well as expectations – what wages and profit margins could support inflation in these stages, if they move in tandem. The European Central Bank has developed Wage trackingTo identify “tipping points” that are not on the horizon. More simply, the classic indicator of negotiated wages, which is very important in the euro area, still indicates at the end of 2023 an annual increase of 4.5%.