Hottest Inflation In History Blindsides ECB Day Before Policy Decision

Christine Lagarde’s job just got a little harder.

A day before the conclusion of the ECB’s February policy meeting, euro-area inflation printed a large upside surprise.

At 5.1%, the flash read for January exceeded the highest estimate from 44 economists. The range was 3.7% to 5%. Consensus expected a deceleration from December. Instead, CPI hit a new record (figure below).

Core ticked lower, to 2.3%, but that too was an upside surprise. Consensus called for 1.9%.

The headline surge was driven by energy prices, which are seen jumping 28.6% in January, up from December’s already blistering pace. Food, alcohol and tobacco prices are seen rising 3.6%.

Notably, the 0.7% upside surprise to consensus on the headline print was the largest going back at least two decades in Bloomberg’s data.

It’s doubtful Lagarde will waver just yet, preferring to wait for March, when she’ll have a new set of forecasts at her disposal. The ECB mapped out a path for bond-buying post-PEPP at its December meeting, citing “progress on the economic recovery and towards [the] medium-term inflation target.” The plan was billed as a taper — a roadmap to normalization. But it entails ramping up “regular” QE temporarily while pandemic QE is wound down.

The question is whether Lagarde is prepared to concede that rate hikes could commence before the end of this year, as market pricing suggests. Complicating things is the need to square the current QE forward guidance with any plans to raise rates. Raising rates carries direct implications for the future of QE, so the GC has to take that into consideration.

On the inflation front, the math may not add up anymore for Lagarde. Last month, BofA’s Michael Hartnett suggested it’s very unlikely inflation will recede to target in the near- to medium-term (figure below).

January’s MoM gain was 0.3%. But as difficult as the math might be, the communications challenge around QE and any attempt to raise rates 25bps (as the market seems to expect) by the end of this year would prove even more daunting. It’s very difficult to image a “hard stop” (as it were) to monthly bond-buying over the next six months.

One FX and rates strategist who writes a daily column for Bloomberg suggested now’s the time for Lagarde to abandon “transitory.” “Investors need stability — and for the Governing Council, it means some convergence between current market pricing and previous forward guidance,” Vassilis Karamanis said Wednesday, before conceding that “a hawkish Lagarde runs the risks of bonds turning excessively bearish, so it [would] take careful communication to keep all sides happy.”

Indeed it would. A “hawkish ECB” isn’t quite on par with a “hawkish Kuroda” when it comes to being a contradiction in terms, but a decade on from “Whatever it takes,” it’s pretty oxymoronic.

“We have to be open to any change to [the] inflation outlook,” Lagarde told a virtual panel during the World Economic Forum late last month. “We will [have] projections in a couple of months that might look different, and at that point I might have to look at my roadmap,” she added.

Weighing in further Wednesday, the above-mentioned Karamanis wrote that communications challenges aside, “an ongoing refusal to admit that there may be a need to act sooner than expected… won’t be reassuring at all, and catching up with market expectations months later could be too difficult.”