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Inflation and the ECB (part 1): the four criteria

Summary:
Euro area inflation was well above consensus in January. However, we believe that the ECB will look through this spike in (imported) inflation as underlying price pressures remain subdued.Although euro area headline inflation jumped to 1.8% in January, the closest it has been to ECB’s 2% target since Q1 2013, core inflation remained low at 0.9%. We continue to expect the ECB to wait until September before it announces a tapering of its asset purchases in 2018.A “sustained adjustment in inflation” (the ECB’s words) will be required before the bank’s monetary stance can be adjusted, based on four criteria: 1) inflation needs to return to the 2% over the medium-term; 2) the adjustment needs to be durable, not transient; 3) self-sustained without monetary support; and 4) defined for the whole region. Our forecasts suggest that three out of four inflation criteria would be met by Q3 2017, allowing the ECB to announce a tapering on a forward-looking basis.The risk is that ECB’s communication shifts to a more hawkish stance earlier, with the next challenge coming in March, when ECB staff projections are revised upwards. As always, we remain confident that Mario Draghi will stand by his words.

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Euro area inflation was well above consensus in January. However, we believe that the ECB will look through this spike in (imported) inflation as underlying price pressures remain subdued.

Inflation and the ECB (part 1): the four criteria

Although euro area headline inflation jumped to 1.8% in January, the closest it has been to ECB’s 2% target since Q1 2013, core inflation remained low at 0.9%. We continue to expect the ECB to wait until September before it announces a tapering of its asset purchases in 2018.

A “sustained adjustment in inflation” (the ECB’s words) will be required before the bank’s monetary stance can be adjusted, based on four criteria: 1) inflation needs to return to the 2% over the medium-term; 2) the adjustment needs to be durable, not transient; 3) self-sustained without monetary support; and 4) defined for the whole region. Our forecasts suggest that three out of four inflation criteria would be met by Q3 2017, allowing the ECB to announce a tapering on a forward-looking basis.

The risk is that ECB’s communication shifts to a more hawkish stance earlier, with the next challenge coming in March, when ECB staff projections are revised upwards. As always, we remain confident that Mario Draghi will stand by his words.

Frederik Ducrozet
Mr. Frederik Ducrozet is a Senior Econoist at Banque Pictet & Cie SA, Research Division. Prior to this, he served as Senior Eurozone Economist at Credit Agricole Corporate and Investment Bank, Research Division from June 2006 till September 2015. He joined Crédit Agricole SA in 2005. Mr. Ducrozet contributed to the various publications of the research department, with a special focus on macroeconomic developments in Eurozone countries, including on the outlook for fiscal policy and the ECB’s monetary policy. Do not hesitate to contact Pictet for an investment proposal. Please contact Zurich Office, the Geneva Office or one of 26 other offices world-wide.

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