European inflation keeps the pressure on central banks

• Headline euro area inflation was in line with our below-consensus forecast, but strong momentum in excess core prices will likely raise concerns among ECB Governing Council members.
• Price data today (including the UK BRC shop price index) cement our view that both the ECB and the Bank of England will hike their key policy rates by 50bp tomorrow, bringing them to 2.50% and 4.00%, respectively.
• The flash January estimate for euro area HICP inflation was 8.5% y-o-y, broadly in line with Nomura’s below-consensus forecast (Nomura: 8.4%; consensus: 8.9%), after printing at 9.2% in December. Core inflation, meanwhile, was unchanged at 5.2% y-o-y, versus widespread expectations of a slowdown.
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BoE: From forceful to conditional hikes

• On the hawkish side, the Bank’s vote for 50bp today had broad agreement, with the same two members voting for no change, but no other members voting for 25bp. The market had been pricing in around 43-44bp for today’s decision.
• However, on the dovish side the Bank is clearly signalling it is approaching the end of the tightening cycle – its recognition that lags in policy will feed through in the coming months, the removal of “forceful” (or variants thereof) and that future tightening will be conditional on inflation pressures being “more persistent”.
• As expected the Bank now thinks the recession will be milder than before. It also revised down its near-term inflation view. But perhaps surprisingly the Bank’s endhorizon view for inflation remains exceptionally weak at close to zero (similar to the November view based on market rates).

ECB stays the course

• The ECB delivered on its widely expected 50bp hike. On quantitative tightening, it announced that reinvestments will be conducted broadly in line with current practices.
• The tone of the meeting was hawkish, and in-line with our expectations. Madame Lagarde made clear that the ECB has more to do, and explicitly pre-committed to a 50bp hike at the March meeting, as we had been forecasting.
• On QT, as expected the ECB made clear the modalities of the APP portfolio redemption reinvestment process. In contrast with our expectations, the ECB chose not to give itself the same flexibility as it has with PEPP portfolio redemption reinvestments. 

European PMIs: a tale of two economies

• Both Spanish and Italian PMIs bounced back strongly in January. This was driven largely by a stronger expansion in the services sector. This adds to the evidence suggesting that euro area growth is proving to be more resilient.
• The PMI price indicators point to some persistence in inflation pressures. Although input price inflation has cooled to its slowest pace since early 2021 for Italy and Spain, output price inflation has been rising. Price pressures in the euro area may not be slowing as quickly as might have been expected.
• French industrial production (IP) grew stronger than expected in December, rising by 1.1% m-o-m. This implies IP fell by 0.7% q-o-q in Q4 as a result of the markedly weak October. Again, this provides more evidence of resilient euro area growth.