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Euro zone inflation unexpectedly hits new record high

LONDON (Reuters) -Euro zone inflation rose to a new record high last month, defying expectations for a big drop and adding to already copious doubts that price pressures are as benign and temporary as the European Central Bank still expects.

FILE PHOTO: Shoppers wear mask and fill Cologne's main shopping street Hohe Strasse (High Street) in Cologne, Germany, 12, December, 2020. REUTERS/Wolfgang Rattay

Inflation in the 19-country euro zone accelerated to 5.1% in January from 5% in December, well ahead of expectations for a drop to 4.4%, the European Union’s statistics agency Eurostat said on Wednesday.

MARKET REACTION:

The euro extended gains and was up 0.3% at a one-week high of $1.13.

Investors expanded increased bets that the ECB will have to tighten policy, with money markets now assigning a 94% probability to a 10 basis point interest rate increase in July, marginally up from 93% before the data, and expecting as much as 30 bps by the end of 2022.

Here are some reactions from economists and analysts:

JOERG KRAEMER, COMMERZBANK CHIEF ECONOMIST

“At 5.1%, the inflation rate for January was miles above the 4.1% the ECB has been forecasting for the first quarter. The unexpectedly high inflation rate is a slap in the face for the ECB. It will have to finally recognise the massively increased inflation risks and take its foot off the pedal of monetary policy.”

LOUIS HARREAU, EURO ZONE ECONOMIST AND ECB STRATEGIST AT CREDIT AGRICOLE:

“The challenge for the ECB is not that the peak is higher, but that it is *longer* than expected: since March 2021 the ECB has been expecting a declining inflation from a peak in Q4 2021, and this morning figures show that Q1 22 will be higher.

This:

1) challenges further ECB’s projection of below 2% inflation in 2023

2) increases risks of second round effects

3) reinforce hawks at the governing council

So complicated meeting tomorrow: we all know that the ECB will have to revise up its projections in March, so hawkish tone from Christine Lagarde.”

CAPITAL ECONOMICS:

“January’s inflation data support our view that the ECB will soon forecast inflation to be at its (2%) target over the medium term.

“We think the ECB will probably follow the plan it outlined in December to reduce asset purchases to 20 billion euros per month by October, and will end them completely soon afterwards. That would prepare the ground for the Bank to raise rates with the first hike in early 2023 – though an increase at the end of this year is certainly possible.”

FREDERIK DUCROZET, STRATEGIST, PICTET WEALTH MANAGEMENT:

“The flash estimate for euro area January 2022 HICP will be remembered as the largest inflation surprise so far relative to consensus expectations. We suspect the ECB will be surprised, too.

“The patience of the hawks is likely to wear thin as underlying inflation pressures continue to build over coming months. Indeed, core inflation is expected to pick up again and the starting point will be much higher, i.e. closer to the levels consistent with “substantial progress”, as per the ECB’s criteria for lift-off.

“We now expect the ECB to bring its deposit rate back to zero in two 25bp rises in March and June 2023, before making a pause in the second half of 2023.”

MARCHEL ALEXANDROVICH, EUROPEAN ECONOMIST AT SALTMARSH ECONOMICS

“It is a surprise compared to most people’s expectations. And there is a concern that what we’ve seen in the U.S., in the UK, we are now seeing in the euro zone as well, and that is that inflation is proving stickier than expected.

“The ECB is not inclined to pivot from meeting to meeting and one data point is not going to change their tone. So I continue to expect Lagarde to sound balanced tomorrow and say inflation will come down and they will react if it doesn’t.”

RALF UMLAUF, HELABA:

“The national read-outs already suggested that the euro zone inflation rate would come out higher than expected, but the rise still was much higher on the upside. Inasmuch, the pressure will remain on the ECB to react faster than thus far signalled to the price rises.

“It will be interesting to see whether the ECB president will ... yet again stress that rate hikes this year are very unlikely. Market players have in the meantime pegged hike expectations for the end of this year and will see this vindicated by the current numbers.”

Reporting by EMEA Markets and Finance Teams; Compiled by Saikat Chatterjee; Editing by Catherine Evans and Jon Boyle

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