On an annual level, inflation in the euro zone was 6.9% in March, which represents a significant reduction after February’s 8.5%. The decrease in annual inflation was expected due to the high base in March last year, analysts even slightly underestimated the decrease in annual inflation, the Reuters consensus was 7.1%.
This in itself is good news, but looking at core inflation, it quickly becomes clear that the situation is much worse.
Annual core inflation increased to 5.7% in March from 5.6% in February. Analysts expected an annual rise in core inflation, the consensus was 5.7%. The increase on a monthly basis is even more worrying: after the 0.8% increase in the previous month, prices increased by 1.2% from February to March.
The core inflation basket does not include products with variable prices, such as food and energy, so it gives a more accurate picture of core inflation processes and better shows what kind of demand-side inflationary pressure prevails in the economy (of course not completely, since energy prices affect a wide range of the economy , for example, spills over into the price of services and manufactured goods). In the current situation, when a significant part of inflation is supply-side, the development of core inflation is more important for the central bank.
While the main inflation indicator is decreasing due to the drop in energy prices, core inflation pressure is not easing and is well above the central bank’s 2% target. The ECB has so far raised interest rates by 350 basis points, most recently in March, and they have promised that further interest rate hikes will come if inflation makes this necessary.
From today’s data, it can be concluded that the ECB’s decision-makers – especially recently they have been particularly vocal – will urge further interest rate hikes. However, the situation is not so simple, because the interest rate hike puts additional pressure on the banking system, while recently there have been concerns about a possible financial crisis after the bank failures (Silicon Valley Bank, Signature, Credit Suisse).
The ECB has until May to consider: if there are no signs of a wider banking crisis by then, the interest rate hike cycle will probably continue (of course, there will also be inflation data for April and May until then, which will also be taken into account during interest rate decisions). If, on the other hand, loan disbursements fall significantly, there is no need for the central bank to raise them any further, as the decline in loan disbursements will also slow down the economy, which will reduce inflationary pressure.
There is still a lot of uncertainty regarding the ECB’s future interest rate decision, and it can also be seen that the weight of the inflation data release in the expectation of the decision has decreased, because some indicators of the banking sector have come into play. Due to the unclear picture, it is not so surprising that the euro did not move in response to today’s inflation data.
Development of the EUR/USD exchange rate
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