Prospects for Euro Area Inflation in 2023

Monday, February 27, 2023

Question 1: How likely is it that peak headline euro area inflation is behind us?

Question 2: Relative to market forecasts of the ECB’s MRO rate peaking at 3.5%, which of the following is more likely during 2023?

Question 3: Under its current policy trajectory, with rates peaking at 3.5%, which of the following is most likely?

Summary

The February 2023 CfM-CEPR survey asked the members of its European panel whether inflation has peaked in the Euro Area and its implications for ECB policy. A large majority of 74% of the panel thinks that inflation has already passed its peak, but half the panel thinks the ECB’s rate will need to rise to above the 3.5% peak currently forecast by market participants to support the rate of inflation reduction. Consistent with this, more than a third of the panel thinks that the ECB’s current trajectory will have interest rates too low to curb inflation.

Background

The February 2023 CfM-CEPR survey asked the members of its European panel about Euro Area inflation ECB policy to combat inflationary pressures.

Has Inflation Peaked?

The European Central Bank released its on 13^th February 2023, presenting its growth outlook and inflation projections for the EU economy. In its Winter 2023 Economic Forecast economic forecast (February 13^th), the ECB states that “three consecutive months of moderating headline inflation suggest that the peak is now behind us.” Inflation in the EU reached an all-time high of 10.6% in October 2022, declining to 8.5% in January 2023. It also revised its EU inflation forecast downwards to 6.4% in 2023 and to 2.8% in 2024. Moreover, the 5y-5y inflation-linked swap for the EU, a common measure of longer-term inflation expectations, moved in a narrow band around 2.3%, indicating that long-term inflation expectations have not de-anchored. Although core inflation still increasing, markets now expect policy rates to peak by mid-year. However, Felke and Philiponnet (2023) argue that while inflation pressures are expected to ease gradually going forward, they will not necessarily take place at an even pace throughout the EU. This makes it particularly challenging to ensure that the single monetary policy is effective throughout the euro area.

The ECB emphasizes that some key inflation risks remain. These include a resurgence of gas prices due to geopolitical tensions and increased demand from a post-lockdown China and higher-than-anticipated wage pressure due a tight labour market. Soldani et al. (2022) show how labour shortages have been on the rise in several advanced economies, which can tamper economic activity, aggravate supply bottlenecks, and trigger increases in inflation.

The ECB Survey of Professional Forecasters (SPF) also predicted similar inflation rates for the EU, with respondents (experts affiliated with financial or non-financial institutions based within Europe) revising their inflation expectations to 5.9% in 2023 and 2.7% in 2024. Bloomberg seconded the ECB’s views, arguing that “headline inflation has peaked [in the EU]” but mentioned that “core inflation will be stickier in the near term.” Credit Suisse expressed similar sentiments, stating “headline inflation may peak in Q4 2022, but core inflation is likely to hover around 5% until mid-2023.” Goldman Sachs echoed these views, stating that they expect inflation to ease faster than thought — to about 3.25% by the end of 2023 compared with earlier forecasts of 4.50%. Economists also forecast core inflation to slow down to 3.3% by the year-end as goods prices cool, but continued upward pressure is expected on services inflation due to rising labour costs. As such, given the “sticky” nature of inflation, Goldman expects the European Central Bank to remain hawkish in the near future.

van der Cruijsen, De Haan and Van Rooij (2023) provide another explanation for the ECB’s hawkish stance. They find that individuals who have higher inflation perceptions and those facing financial difficulties have lower levels of trust in the ECB. Given that van der Cruijsen and Samarina (2021) found that trust in the ECB facilitates better anchoring of inflation expectations, losing trust will make it harder for the ECB to bring inflation back to target. Hence, the ECB needs to reduce inflation as quickly as possible to reduce this erosion in trust and maintain the efficacy of its monetary policies.

The Policy Response

On 2^nd February, the ECB decided to raise the key ECB interest rates by 50 basis points, bringing the interest rate on the main refinancing operations (MRO) to 3.00%. The ECB has maintained a markedly hawkish tone regarding inflation, with President Christine Lagarde stating saying “we have ground to cover” due to high core inflation rates. In its statement on February 2^nd, the ECB stated its intention to raise interest rates by another 50 basis points in March and then “then evaluate the subsequent path of its monetary policy.” While acknowledging the concern regarding overtightening, Mario Centeno (Governor of the Bank of Portugal) stated that the ECB intends to have “at least” a few more rate hikes in 2023 to tackle inflation.

Similarly, the ECB SPF expected the ECB’s key MRO interest rate to increase to 3.0% in the first quarter of 2023 and to 3.5% in the second quarter of 2023, before easing slightly in 2024 and in 2025 to below 3%. Bloomberg Economics also expressed similar views, stating: “We expect this will keep the ECB hiking at least through Q1, 2023.” Oxford Economics also stated, “We think that falls in headline inflation will do little to stem the central bank’s hawkishness.”

Most banks believe the ECB will continue to hike interest rates beyond its intended 50-bp hike in March. Goldman Sachs sees “two further 0.25% rate hikes in May and June, implying a 3.5% terminal rate in the summer.” Some banks felt that the ECB wasn’t doing enough to anchor future inflation expectations and needed to clearly state its intention to hike interest rates by more than the planned amount. Commerzbank stated that they “continue[d] to believe that a deposit rate of about 4% is necessary”, while Société Générale claimed that the ECB is rather “taking the risk of doing too little than too much tightening to reach the target.” Nordea echoed these sentiments, claiming “Lagarde’s comments strongly suggest that the ECB is planning to continue rate hikes also beyond March.” ING also expressed similar views: “As long as core inflation remains stubbornly high and core inflation forecasts remain above 2%, the ECB will continue hiking rates.”

However, some other banks expect the ECB to adopt a more dovish approach and end its tightening cycle in March. ABN Amro “continue[s] to expect the deposit rate to peak at 3%, which implies that the 50 basis-point rate hike in March would be the final one and that rates will be kept on hold for a while after that.” Berenberg indicated similar sentiments: “As inflation looks set to decline, we expect [the ECB] to push back against further major rate hikes in the second quarter.”

This month’s CfM-CEPR survey asked the panel about the prospects for inflation in the Eurozone. It included three questions. The first asks whether inflation has peaked. The second asks whether the ECB will raise interest rates above 3.5%, as its MRO rate is currently projected to peak. The third question asks whether the currently projected 3.5% peak rate will be sufficient to curb inflation.

How the experts responded

Question 1

Participant	Answer	Confidence level	Comment
Michael McMahon University of Oxford	Likely	Confident	But the peak being behind us and the inflation challenge for central banks being behind us are not necessarily the same thing. If inflation comes down and settles in the 4-5% range, it still poses a big challenge for policymakers to determine how quickly to bring it back to target.
Ricardo Reis London School of Economics	Likely	Confident	Another large energy shock does not seem in the horizon. The last few months have had energy contributing to very low inflation, and the next several months will likewise be in the same direction. So, while core inflation may well not have peaked, headline probably has peaked. I would add that if inflation was to exceed 10% again, several months after October 2022, this would be a serious indictment of monetary policy that has a 2% target.
Nicholas Oulton London School of Economics	Likely	Confident
Stefan Gerlach EFG Bank	Very likely	Confident	For headline inflation to rise further, a large additional shock is required. While that can always happen, it seems unlikely.
David Cobham Heriot Watt University	Very likely	Confident
Jorge Braga de ... Nova School of Business and Economics, Lisbon	Unlikely	Confident	The expression attributed to the Portuguese governor of «“at least” a few more rate hikes» should not ignore that major central banks are once again adding liquidity to global financial markets and a US debt ceiling crisis may confront the Fed.
Robert Kollmann Université Libre de Bruxelles	Roughly even odds	Not confident at all	The outlook for inflation in the Eurozone is extremely uncertain, so it is currently impossible to tell whether inflation has reached a turning point. This uncertainty is due to several important factors, including the ECB's willingness to continue to raise interest rates, fiscal risks and ongoing developments in the war in Ukraine.
Ugo Panizza The Graduate Institute, Geneva (HEID)	Very likely	Extremely confident	Lower energy prices and ECB response will keep bringing inflation down
Jean Imbs Paris School of Economics	Unlikely	Not confident
Martin Ellison University of Oxford	Likely	Not confident
John VanReenen London School of Economics	Likely	Not confident
Simon Wren-Lewis University of Oxford	Very likely	Very confident
Łukasz Rachel UCL	Likely	Confident	Headline in the near term will be driven primarily by falling energy prices so I expect it to decline.
Sir Charles Bean London School of Economics	Likely	Not confident
Paul De Grauwe London School of Economics	Likely	Not confident
Lucio Sarno Cambridge University	Likely	Confident
Philip Jung University of Dortmund	Roughly even odds	Confident
Wouter Den Haan London School of Economics	Very likely	Not confident
Antonio Fatás INSEAD, Singapore	Very likely	Very confident
Natalie Chen University of Warwick	Likely	Confident
Michael Wickens Cardiff Business School & University of York	Likely	Confident	The issue for EU monetary policy is not whether inflation has peaked but whether inflation is coming down fast enough for interest rates to stop being increased. Given that the ECB was well behind the curve on raising rates as inflation took off, a further rise might still be required.
Linda Yueh London Business School	Likely	Not confident
Gernot Müller Eberhard-Karls-Universität Tübingen	Likely	Confident
Costas Milas University of Liverpool	Very likely	Confident	Confident
Roger Farmer University of Warwick	Very likely	Confident	There is considerable co-movement in inflation rates across major developed economies and the Euro area the UK and the US are all showing signs that inflation has peaked and will slowly fall. This is consistent with the sources of the inflation which appear to be linked to the temporary spike in deficits caused by Covid relief packages and the spike in oil prices generated by Putin's invasion of the Ukraine.
Nicola Fuchs-Sc... Goethe University Frankfurt	Likely	Confident
Alessandra Bonf... Queen Mary University of London	Likely	Confident
Cédric Tille The Graduate Institute, Geneva	Likely	Confident
Jürgen von Hagen Universität Bonn	Likely	Very confident	Much of this depends on what happens in the Ukraine. If Russia prevents grain exports or destroys the grain harvest, food prices could go up a lot more and drive up headline inflation again.
Ethan Ilzetzki London School of Economics	Roughly even odds	Not confident

Question 2

Participant	Answer	Confidence level	Comment
Michael McMahon University of Oxford	The MRO rate will peak above 3.5%.	Confident
Ricardo Reis London School of Economics	The MRO rate will peak above 3.5%.	Very confident	A tougher question than where will be the peak is is how long will interest rates there. A while, I think.
Nicholas Oulton London School of Economics	The MRO rate will peak at 3.5%	Confident
Stefan Gerlach EFG Bank	The MRO rate will peak below 3.5%	Not confident	While the euro area economy has been surprisingly unaffected by tighter monetary policy, the ECB started raising interest rates only in July. There is thus plenty of tightening in the pipeline. I would not be surprised if the euro area economy were to slow markedly, forcing the ECB to reconsider the outlook for interest rates.
David Cobham Heriot Watt University	The MRO rate will peak at 3.5%	Confident
Jorge Braga de ... Nova School of Business and Economics, Lisbon	The MRO rate will peak above 3.5%.	Confident	As German 2y bonds hit 3% and the S&P Global purchasing managers’ index outstrips forecasts, the expected sharp rise in salaries will maintain pressure on prices.
Robert Kollmann Université Libre de Bruxelles	The MRO rate will peak above 3.5%.	Not confident	Given that Eurozone headline and core inflation rates were close to 9% and 6%, respectively, in January 2023, the ECB should raise the policy rate much higher than 3.5% in 2023. If the fight against inflation is lost, the ECB’s reputation will be damaged for years to come. As a result, it is likely that the MRO rate will be raised to above 3.5% in 2023.
Ugo Panizza The Graduate Institute, Geneva (HEID)	The MRO rate will peak at 3.5%	Not confident
Jean Imbs Paris School of Economics	The MRO rate will peak above 3.5%.	Not confident
Martin Ellison University of Oxford	The MRO rate will peak at 3.5%	Not confident
John VanReenen London School of Economics	No response	Not confident at all
Simon Wren-Lewis University of Oxford	The MRO rate will peak above 3.5%.	Not confident
Łukasz Rachel UCL	The MRO rate will peak at 3.5%	Not confident	At or a little above 3.5%. I think the ECB might now move by 25bps per meeting
Sir Charles Bean London School of Economics	The MRO rate will peak above 3.5%.	Not confident
Paul De Grauwe London School of Economics	The MRO rate will peak above 3.5%.	Confident
Lucio Sarno Cambridge University	The MRO rate will peak at 3.5%	Not confident
Michael Wickens Cardiff Business School & University of York	The MRO rate will peak above 3.5%.	Confident	The further increases reflect the slow fall in inflation and that the ECB is still behind the curve in responding to the earlier sharp rise in inflation.
Philip Jung University of Dortmund	The MRO rate will peak at 3.5%	Not confident
Wouter Den Haan London School of Economics	The MRO rate will peak at 3.5%	Not confident
Antonio Fatás INSEAD, Singapore	The MRO rate will peak at 3.5%	Confident
Natalie Chen University of Warwick	The MRO rate will peak above 3.5%.	Not confident
Linda Yueh London Business School	No response	Not confident
Gernot Müller Eberhard-Karls-Universität Tübingen	The MRO rate will peak at 3.5%	Not confident
Costas Milas University of Liverpool	The MRO rate will peak above 3.5%.	Confident	I believe the ECB will be keen to make sure that its policy rate exceeds slightly the forecast of inflation so that the real interest rate becomes positive.
Roger Farmer University of Warwick	The MRO rate will peak above 3.5%.	Confident	ECB rate setters appear to be on a path to continue rate hikes. Given the makeup of the committee I do not expect them to back down.
Nicola Fuchs-Sc... Goethe University Frankfurt	The MRO rate will peak above 3.5%.	Not confident
Alessandra Bonf... Queen Mary University of London	The MRO rate will peak at 3.5%	Not confident
Cédric Tille The Graduate Institute, Geneva	The MRO rate will peak above 3.5%.	Confident
Jürgen von Hagen Universität Bonn	The MRO rate will peak above 3.5%.	Confident
Ethan Ilzetzki London School of Economics	The MRO rate will peak at 3.5%	Confident

Question 3

Participant	Answer	Confidence level	Comment
Volker Wieland Goethe University Frankfurt and IMFS	ECB policy interest rates will be too low in 2023.	Confident
Michael McMahon University of Oxford	ECB policy interest rates will be too low in 2023.	Confident
Ricardo Reis London School of Economics	ECB policy rates will be appropriate in 2023.	Not confident	Not even the ECB is confident, since at this inflection point, there is a lot of uncertainty. As in the previous question, more than whether the peak is 3.5, 3.75 or 4%, is how long will be needed to keep rates there to bring inflation decisively back on target
Nicholas Oulton London School of Economics	ECB policy rates will be appropriate in 2023.	Not confident
Stefan Gerlach EFG Bank	ECB policy interest rates will be too high in 2023.	Not confident
David Cobham Heriot Watt University	ECB policy rates will be appropriate in 2023.	Confident
Matthias Doepke London School of Economics	ECB policy interest rates will be too low in 2023.	Not confident
Mirko Wiederholt Science Po	ECB policy interest rates will be too low in 2023.	Not confident
Ugo Panizza The Graduate Institute, Geneva (HEID)	ECB policy rates will be appropriate in 2023.	Confident
Jorge Braga de ... Nova School of Business and Economics, Lisbon	ECB policy rates will be appropriate in 2023.	Not confident	Rising non-US central bank flows and investor optimism about growth would keep ECB policy rates appropriate if geopolitical tensions abate but I am not confident that they will.
Jean Imbs Paris School of Economics	ECB policy interest rates will be too low in 2023.	Not confident
Martin Ellison University of Oxford	ECB policy interest rates will be too high in 2023.	Not confident
John VanReenen London School of Economics	ECB policy rates will be appropriate in 2023.	Not confident
Simon Wren-Lewis University of Oxford	ECB policy interest rates will be too high in 2023.	Confident	Since the end of 2019, the US has grown by around 5%, while growth in Germany and France is only just over zero and 1% respectively. This suggests that Germany and France are operating below capacity, so strong rate increases make little sense. The ECB is overreacting.
Łukasz Rachel UCL	ECB policy rates will be appropriate in 2023.	Not confident
Vincent Sterk University College London	ECB policy rates will be appropriate in 2023.	Confident
Evi Pappa European University institute	ECB policy rates will be appropriate in 2023.	Confident
Sir Charles Bean London School of Economics	ECB policy interest rates will be too low in 2023.	Not confident
Paul De Grauwe London School of Economics	ECB policy interest rates will be too high in 2023.	Confident
Lucio Sarno Cambridge University	ECB policy rates will be appropriate in 2023.	Confident
Michael Wickens Cardiff Business School & University of York	ECB policy interest rates will be too low in 2023.	Confident	See comments to previous questions
Philip Jung University of Dortmund	ECB policy rates will be appropriate in 2023.	Not confident
Wouter Den Haan London School of Economics	ECB policy rates will be appropriate in 2023.	Confident
Richard Portes London Business School and CEPR	ECB policy interest rates will be too high in 2023.	Confident
Antonio Fatás INSEAD, Singapore	ECB policy rates will be appropriate in 2023.	Confident
Natalie Chen University of Warwick	ECB policy rates will be appropriate in 2023.	Confident
Robert Kollmann Université Libre de Bruxelles	ECB policy interest rates will be too low in 2023.	Confident
Linda Yueh London Business School	No response	Not confident
Maria Demertzis Bruegel	ECB policy rates will be appropriate in 2023.	Confident
Gernot Müller Eberhard-Karls-Universität Tübingen	ECB policy interest rates will be too low in 2023.	Confident
Costas Milas University of Liverpool	ECB policy interest rates will be too low in 2023.	Confident	Assuming a policy rate of 3.5% but inflation in excess of that level, a negative real interest rate would most likely sustain existing market distortions.
Alessandra Bonf... Queen Mary University of London	ECB policy rates will be appropriate in 2023.	Not confident
Roger Farmer University of Warwick	ECB policy interest rates will be too high in 2023.	Confident	My answer is based on the supposition that rates peak ABOVE 3.5%. Long term real interest rates appear to be falling world-wide as a consequence of demographics and slow-down in productivity growth. I am concerned that a path of interest rates that goes beyond the current planned hike to 3.5% will be overkill and will trigger a recession. Asset markets already appear nervous. Further rate hikes will sppok them further and that will not be good for employment and growth.
Nicola Fuchs-Sc... Goethe University Frankfurt	ECB policy interest rates will be too low in 2023.	Not confident
Cédric Tille The Graduate Institute, Geneva	ECB policy rates will be appropriate in 2023.	Confident
Jürgen von Hagen Universität Bonn	ECB policy interest rates will be too low in 2023.	Confident
Ethan Ilzetzki London School of Economics	ECB policy interest rates will be too low in 2023.	Not confident

How the experts responded

Question 1

Question 2

Question 3

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